chapter 7 study of price escalation clause in...
TRANSCRIPT
149
CHAPTER 7
STUDY OF PRICE ESCALATION CLAUSE IN BUILDING
CONSTRUCTION CONTRACTS IN INDIA
7.1 INTRODUCTION
Generally, in the construction industry, the contractor works in an
environment of risk and uncertainty caused by the economic factors such as
fluctuations in the costs of materials, labour and equipment. Contractors and
suppliers working in today’s volatile materials market find that estimating,
bidding and financing the construction projects are challenges. Many face
significant losses or erosion of anticipated profits because many of them are
locked into fixed price construction contracts where contractors bear the risk
of material price and supplier cost increases. Without the price escalation
clause that allows for an adjustment to the contract price, if there is an
unexpected rise in the market prices of key construction materials, a
contractor will have no respite from such increases. It is necessary to have an
escalation clause in the contract to guard against a sudden spurt in the cost of
materials. To reduce this degree of risk, it is necessary for the contractor to
include large contingencies in initial estimates of the contract when he
tenders the contract. If the contingencies are overestimated, the probability of
the contract being awarded to another contractor is increased. On the other
hand, if the contractor does not allow for inflation and interest rate correctly,
his initial tender would be too low and he would suffer significant losses
(Keller et al., 1982). In high inflationary times, one solution to mitigate the
150
effect of cost escalation is the use of escalation clauses in the contract
(Touran and Lopez 2006). Inflationary trends in economy, boom in
construction activity, seasonal affects and cost of borrowing money have
increased the inherent risk present in construction projects (William 1994,
Keller 1982). This risk could be minimized by inclusion of a escalation
clause in the construction contract (Blair 1993, Panchadhari 1992, Kalra
1983). Escalation clauses are used in the contract to avoid cost overrun by
the contractor and reduce the contingency amount in the contractor’s bid.
7.2 OBJECTIVES
The objectives of the present study are to (i) study the escalation
clauses presently used in construction contracts adopted by various
Government departments/ agencies in India (ii) the adequacy of
compensation paid to the contractor based on currently used escalation
clauses in government contracts and (iii) how far cost escalation has impact
on the outcome of construction projects.
7.3 METHODOLOGY
This investigation was undertaken in two phases. The first phase
included a literature review and interviews conducted among experts with
more than 25 years of experience in construction projects such as Chief
Engineers, Directors (Contracts) and Superintending Engineers. The second
phase included a questionnaire survey. Questionnaires were directed towards
representatives from Government client organizations and contractors. The
questionnaires were distributed to client representatives in the level of
Assistant Engineers to Chief Engineers of CPWD, MES and TNPWD and
contractor representatives who have executed projects for these
organizations.
151
7.4 NEED FOR PROPER ESCALATION CLAUSES IN
GOVERNMENT CONSTRUCTION CONTRACTS
During the past few years there has been a steep increase in the
prices of steel, cement, brick, coarse aggregates, sand and other building
materials. The price of cement, steel and brick for the past five years i.e. from
2003 to 2008 is shown in Figures 7.1, 7.2 and 7.3 respectively.
125160 170
210
255 260
0
50
100
150
200
250
300
2003 2004 2005 2006 2007 2008
Year
Pric
e of
cem
ent p
er b
ag (i
n R
s)
Cementprices
Figure 7.1 Prices of construction materials – Cement Source: Builders Association of India (Southern Centre)
15000
2650029500 30500 32500
55000
0
10000
20000
30000
40000
50000
60000
2003 2004 2005 2006 2007 2008
Year
Pric
e of
ste
el p
er M
T (in
Rs)
Steel prices
Figure 7.2 Prices of construction materials – Steel Source: Builders Association of India (Southern Centre)
152
48006000
7500
10000
12500 13000
0
2000
4000
6000
8000
10000
12000
14000
2003 2004 2005 2006 2007 2008
Year
Pric
e of
brick
s pe
r 300
0 N
os(R
s)
Cost of Bricks
Figure 7.3 Prices of construction materials – Brick
Source: Builders Association of India (Southern Centre)
From Figures 7.1, 7.2 and 7.3, it is seen that price of cement has
gone up by about 112% ; the price of steel products has gone up by about
267%; and prices of bricks has gone up by about 171%. There have been
similar increases in the cost of sand, coarse aggregates and other items used
by the construction industry. The rise in wholesale price index for all
commodities, cement and steel from1996 to 2007 is as shown in Table 7.1.
Table 7.1 Wholesale Price Index in India (Base: 1993-94)
Year/Index 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
All commodities
125.6 131.3 138.9 143.8 152.8 160.7 164.7 173.4 184.9 193.7 203 212.8
Cement 137 129.2 129.3 129.5 129.3 150.5 145.1 146.2 151.1 162.5 190.1 213
Steel 121.9 128.4 132.7 133.9 136.2 136.6 140.8 168.3 222.5 253.5 246.1 269.4
From Table 7.1, it is seen that between 1996 and 2007, the index
of cement has gone up by about 56%; the index of steel products has gone up
by about 121% and, index of all commodities have gone up by about 70%.
153
Considering the continuous fluctuation in material prices and wages of
labour, there is a need to have proper escalation clauses in construction
contract. The basic rationale for a price escalation clause is to compensate the
contractor for increase in construction costs which are beyond the control of
both parties.
7.5 CURRENTLY USED ESCALATION CLAUSES IN
GOVERNMENT CONSTRUCTION CONTRACTS
In India, Government departments, organizations, public sector
undertakings have adopted different formulae to compensate the contractor
on the price variations of materials, labour and Petroleum, Oil and Lubricant
(POL). However, some departments continued with fixed rates of contracts
without allowing any compensation to contractor. Some typical escalation
formulae used in central/ state government construction contracts namely
Central Public Works Department, Military Engineer Services, Tamil Nadu
Public Works Department are given in Table 7.2. Escalation clauses adopted
in Airports Authority of India and Bharat Sanchar Nigam Limited are similar
to CPWD escalation clause, hence these formulas adopted by them are not
shown in the Table 7.2. An overview of the escalation clauses used in
Government contract is shown in Table 7.3, which shows the type of
escalation clause, project duration where the escalation clause is applicable
in the contract, components involved for the escalation, type of index used
for materials and labours in the contract. The details of escalation clauses
used in construction contracts in India is presented in Appendix 2.
154
Table 7.2 Escalation formulae used in construction contracts adopted by various government departments/ agencies in
India
Item Compensated
Central Public Works Department Military Engineer Services Tamil Nadu
Public Works Department
Cement c 0C
0
X CI CIV W100 CI
--Nil-- CC
PV 0.85 R100
1 0
0
C CC
Steel S 0
S0
X SI SIV W100 SI
--Nil--
Ss
PV 0.85 R100
1 0
0
S SS
Materials
0M
0
MI MIXmV W100 MI
0
0
CI CIV P QCI
1 0M M2 M1
0
W WE V VW
MM G S B
KV V V V100
mM
PV 0.85 R100
1 0
0
M MM
Plant and Machinery spares --Nil - --Nil --
ps
PV 0.85 R
100
1 0
0
P PP
POL 0F
0
FI FIZV W100 FI
PE = PG1
K V100
1 0
0
F FF
fP
PV 0.85 R100
1 0
0
F FF
Labour 0L
0
LI LIYV W100 LI
LE = LG1
K V100
1 0
0
L LL
lL
PV 0.85 R100
1 0
0
L LL
Bitumen --Nil - --Nil - bP
PV 0.85 R100
1 0
0
B BB
155
Client organisations have now incorporated escalation clause in
the contract conditions. But the question is the efficacy of escalation clause
and how well they compensate the contractor The basic formula approach
remains the same everywhere with only percentage of profit, material, labour
and POL component being the varying part. The study is focusing on base
period, index associated with the clause, time period and extension of time
and other relevant conditions.
Table 7.3 Overview of the escalation clauses presently used in construction
contracts adopted by various government departments /
agencies in India
Description Central Public Works
Department
Military Engineer Services
Tamil Nadu
Public Works Department
Airports Authority of India
Bharat Sanchar Nigam
Limited
Compensation shall be payable for works whose stipulated period of completion is
6 months or less
0 to 18 months
> 18 months
> 6 months > 12 months > 6 months
> 12
months
Clause in the general conditions of contract
10C 10CA 10CC Special
conditions Special
conditions 10CC 10C
Components involved for escalation Material
and Labour
Material
Cement
Steel
Materials
POL
Labour
Material
POL
Labour
Cement, Steel,
Material, POL
Labour, Bitumen, Plant and Machinery
Spares
Material
POL
Labour
Cement
Steel
Material
POL
Labour
Index used for materials
-- WPI WPI WPI WPI WPI WPI
Index used for Labour
-- CPI CPI CPI CPI CPI CPI
156
From the above, it is clear that in all government construction
contracts, the escalation in material prices is measured by using wholesale
price index and escalation in labour prices are measured by using the
consumer price index.
7.5.1 Escalation Clauses in Central Public Works Department
In India, Central Public Works Department (CPWD) deals with
public works of central government works in the country. CPWD is more
than 150 years old and contract forms of the CPWD form the basis of many
other contract forms followed by other Central and State Government
Departments. For the first time in March 1963, a sub-clause 10C was
introduced in CPWD contract forms (Gupta, 1992). In the current CPWD
Contract agreement, there are three escalation clauses namely Clause 10C,
Clause 10CA and Clause 10CC (General conditions of contract for CPWD
works (2008)). These are summarized below.
7.5.1.1 Project completion time 6 months or less
Clause 10C, under this clause increases as a direct result of coming
into force of any fresh law, statutory rule or order (but not due to change in
sales tax/ VAT) in the prices of any materials and wages of labour beyond 10
percent of the price prevailing at the time of receipt of the tender for the work
are reimbursable. Whereas materials issued by the department at a fixed
recovery rate are not affected. Base time for purpose of this clause is the date
of receipt of tender and the clause is applicable during the stipulated period
of contract or duly extended period of work. Any increase/ decrease is not to
be considered if the same occurred due to delay on the part of contractor.
Engineer-in-charge’s decision in this regard is final and binding. The
contractor is required to keep books of records and other documents as are
157
necessary to show the amount of any increased claim and also required to
intimate the department of such increase in a reasonable time.
7.5.1.2 Project completion time between 0 to 18 months
Clause 10 CA, under this clause contractor is compensated for
increases/decreases beyond the price(s) prevailing at the time of the last
stipulated date for receipt of tenders (including extensions, if any) for the
work, then the amount of the contract shall accordingly be varied and
provided further that any such variations shall be effected for stipulated
period of contract including justified period extended under the provisions of
Clause 5 of the contract without any action under Clause 2. However, for the
work done/ during the justified period extended as above, it will be limited to
indices prevailing at the time of stipulated date of completion or as prevailing
for the period under consideration, whichever is less. The increase/ decrease
in prices shall be determined by the All India Wholesale Price Indices for
Materials as published by Economic Advisor to Government of India,
Ministry of Commerce and Industry and base price for materials as issued
under the authority of Director General (Works), CPWD as valid on the last
stipulated date of receipt of tender, including extension if any and for the
period under consideration. In case, price index of a particular material is not
issued by Ministry of Commerce and Industry, then the price index of nearest
similar material as indicated in schedule ‘F’ shall be followed
7.5.1.3 Projects completion time more than 18 months
Clause 10CC, under this clause, the contractor is compensated for
increases in the prices of cement, materials, Labour, POL as per formula
given in Table 7.2. The method prescribed for working out such increases for
the work done during the stipulated period or duly extended period of the
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contract. Escalation is payable on 85 percent of the work done as per the bill,
running or final after deducting the value of materials supplied at fixed prices
by the department and some other items which are payable at the market rate
prevailing at the time when the work is executed. The increases for materials
and Labours are worked out on the basis of indices issued by Ministry of
Commerce and Industry and Ministry of Labour respectively. The month in
which the tenders were stipulated to be received is considered as the base
month. The escalation is worked out quarterly including the month in which
the tender was accepted and thereafter at 3 months interval. The relevant
index for any quarter for which escalation is payable is the arithemetic
average of the indices relevant to 3 previous calendar months. The value of
materials supplied by the department at fixed rates and hire charges of plant
and machinery issued by the department are deducted. Full value of material
for which secured advance is paid is included in the cost worked out as
above and later on adjusted when materials are consumed. The components
of cement, steel, materials, labour and P.O.L etc are pre-determined for every
work and incorporated in the conditions of contract attached to the tender
papers and decision of Engineer-in-charge in working out such percentage
shall be binding on the contractor.
7.5.2 Escalation Clauses in Military Engineer Services (MES)
The price variation clause is applicable only for works whose
completion period stipulated in the tender is more than six months,
irrespective of the cost of the project. Period of working out the variation in
escalation payment is three months. Complete set of drawings are issued by
the client before the work starts and hence contractor can estimate and plan
the project properly. The contractor is not eligible for escalation payment
beyond original project duration even if the delay is due to the owner. No
adjustment, whatsoever, due to variation in prices of materials and fuel and
159
rate of wages of labour on account of coming into force of any fresh law or
statutory rule or order as provided for in the conditions of contract is made.
No adjustment in price system is made for materials brought at site after the
due date of completion or after extension of time granted under the contract
(whichever is later) for the works done under the contract. For labour
component though the escalation is paid on the Minimum Wages still the rise
will be payable on the basis of wages increase of unskilled male mazdoor and
not of other categories. The clause is highly unjustified. Entire amount is
eligible for escalation and profit component is not excluded from the price
adjustment clause. The last adjustment for variation in wages of labour is
done for period ending on the date of completion or extended' date of
completion. No adjustment is however made for work done after due date of
completion or extension of time granted under conditions of contract. The
first price adjustment in respect of variation in wages of labour is worked out
for the relevant quarter during which the variation takes place
For implementing this provision, the period of reckoning in such
quarters is split into two periods i.e. the first period upto which RAR is
payable immediately after the date of variation and the second period upto
the end of the quarter. Value of L1 at the beginning of the second period is
the altered rate of wages. If there are more than one change in wages in a
quarter then there will be more than one or two periods of reckoning on
similar basis. Amount payable to work done for any quarter is worked out
after the minimum wage of unskilled adult male mazdoor as fixed under any
law statutory rule or order for the relevant quarter are available. For purpose
of calculation of retention money. LD, the recovery of water charges, income
tax, the value of contract as revised by the above price is binding Wholesale
Price Index applicable for any date shall be the one applicable for the
corresponding week ending Saturday. The weekly index numbers of
160
Wholesale Price Index for all commodities published by the Economic
Advisor to the Government of India is generally formed provisional. Final
index numbers for the corresponding weeks are published subsequently. It is
to be ensured that the variations arc worked out based on the Final index
numbers only.
The Comparison study of Escalation Formula with various
countries is presented in Table 7.4.
Table 7.4 Comparison of Escalation Formula With Various Countries
Formula India Brazil Malaysia UK Selection Basis CPWD By Client General basic Standard Adjustment Trigger
Time Time Cost % variation Time
Coefficients Proportional to contract work set by Engineer.
Fixed Set by contractor Set by Engineer
Material Selection
All commodities whole sale index used.
By FGV By Engineer By Engineer
Ruling Base Date
Time of Tender Set by Contractor
30 days before the tender due date.
42 days before the tender due date.
Certificate Index Date
Quarter prior to Certificate
Month of Certificate
Date of proved cost
42 days before certificate.
Fixed Component
15% none Variable 30-50% set by Engineer
Variable 10-20% set by Government.
Scope Labour, Materials, POL
Taxes, Labour, Materials, Fuel and Plant
Labour Materials and Plant
Labour, Material and Plant
Source : Mechanisms for Adjusting Price Variations. Papers on price Variation Clause :
NICMAR Publication.
161
7.6 SURVEY RESULTS AND DISCUSSIONS
To study the adequacy and the extent of price escalation
compensation to the contractor based on the currently used escalation clause
in government contracts and also need to improve the currently used
escalation in Government Construction contracts in India a questionnaire
survey was undertaken. Out of 215 questionnaires sent/delivered directly to
the concerned, 119 responses were received were after personal requests and
visits to their respective offices. The response rate of 56 percent is considered
to be very good for this kind of a mail survey. During such visits, along with
questionnaire responses, discussions/unstructured interviews were also
carried out with the above respondents.
Questions regarding how the cost escalation has an impact on the
quality of the project produced, project completion time, source of dispute
between clients and contractors and need to improve the currently used
escalation clauses in government construction contracts were asked from the
respondents to indicate their responses based on overall project experience.
The summary of responses received from the respondent is presented in
Table 7.5.
162
Table 7.5 Summary of responses regarding how the cost escalation has
impact on the construction projects
Impact of cost
escalation on
Disagree Agree
Stro
ngly
Mod
erat
ely
Slig
htly
Neu
tral
Slig
htly
Mod
erat
ely
Stro
ngly
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Quality of the project produced
Client 66 no.
No. of resp 2 1 -- 4 14 24 21 %ge 3.0% 1.5% -- 6.1% 21.2% 36.4% 31.8%
Contractor 53 no.
No of resp 12 18 6 1 9 5 2 %ge 22.6% 34.0% 11.3% 1.9% 16.9% 9.4% 3.8%
Project Completion time
Client 66 no.
No. of resp 1 -- 1 -- 4 16 44 %ge 1.5% -- 1.5% -- 6.1% 24.2% 66.7%
Contractor 53 no.
No of resp 0 1 0 0 2 20 30 %ge -- 1.8% -- -- 3.8% 37.7% 56.6%
Source of dispute
Client 66 no.
No. of resp -- 1 1 -- 7 24 33 %ge -- 1.5% 1.5% -- 10.6% 36.4% 50.0%
Contractor 53 no.
No of resp 0 0 0 1 0 10 42 %ge -- -- -- 1.9% -- 18.9% 79.3%
There is a need to improve the currently used escalation in Government construction contracts
Client 66 no.
No. of resp -- -- -- -- 5 12 49 %ge -- -- -- -- 7.6% 18.2% 74.2%
Contractor 53 no.
No of resp 0 0 0 0 0 8 45 %ge
-- -- -- -- -- 15.1 84.9%
From Table 7.5 the survey results show that about 90% of the
client representatives are of the opinion that cost escalation affects the quality
of the project produced and about 69% of the contractors representatives they
disagree that the cost escalation affects the quality of the project produced.
About 97% of the clients and 98% of contractors representatives they agree
that the cost escalation affects the delay in completion of the projects. About
163
98% of the contractor’s representatives and 94% of clients representatives are
of the opinion that the cost escalation is a source of dispute. All the clients
representatives and contractors representatives are of the opinion that there is
need to improve the currently used escalation clause in Government
construction contracts.
Questions regarding the what extent to which the compensation as
per the currently used escalation clause in Government contracts reflect the
actual price escalation for the components of cement, steel, materials, labour,
petroleum, oil and lubricant were asked from the respondents to indicate
their responses based on overall project experience. The summary of
responses received from the respondent is presented in Table 7.6.
From Table 7.6, compensation to the contractors based on the
currently used escalation clause in government contracts, the survey result
shows that about 98% of contractors representatives and 85% of the clients
representatives are of the opinion that they are compensated less than 60% of
the actual escalation of the cement prices. Similarly, about 95% of the
contractor representatives and 88% of the clients representatives are of the
opinion that they are compensated less than 60% of the actual escalation of
the steel prices. On compensation towards price escalation on materials, 96%
of the contractors representatives and 94% of the clients representatives are
of the opinion that they are compensated less than 60% of the actual
escalation of the material prices.
164
Table 7.6 Summary of responses in regard to what extent does the
compensation as per currently used escalation clause reflect the
actual escalation
Respondent Type < 50%
50-60%
60-70%
70-80%
80-90%
90-100%
>100%
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Cement
Client 66 no.
No. of resp 49 8 6 -- 3 -- -- %ge 74.2% 12.1% 9.1% -- 4.5% -- --
Contractor 53 no.
No of resp 41 11 1 -- -- -- -- %ge 77.4% 20.8% 1.9% -- -- -- --
Steel
Client 66 no.
No. of resp 43 15 6 -- 2 -- -- %ge 65.2% 22.7% 9.0% -- 3.0% -- --
Contractor 53 no.
No of resp 35 15 2 1 -- -- -- %ge 66.0% 28.3% 3.8% 1.9% -- -- --
Materials
Client 66 no.
No. of resp 50 12 2 2 %ge 75.8% 18.2% 3.0% 3.0%
Contractor 53 no.
No of resp 41 10 1 1 %ge 77.4% 18.9% 1.9% 1.9%
Labour
Client 66 no.
No. of resp 42 17 5 2 %ge 63.6% 25.8% 7.6% 3.0%
Contractor 53 no.
No of resp 30 17 4 2 %ge 56.6% 32.1% 7.5% 3.8%
POL
Client 66 no.
No. of resp 43 16 6 1 %ge 65.1% 24.2% 9.1% 1.5%
Contractor 53 no.
No of resp 38 12 2 1 %ge 71.7% 22.6% 3.8% 1.9%
With regard to compensation towards price escalation on POL,
about 90% of client’s representatives and 94% of the contractor’s
representatives are of the opinion that they are compensated less than 60% of
the actual escalation of POL. Similarly, on compensation towards price
escalation on Labour, 90% of the clients and contractor representatives are of
the opinion that they are compensated less than 60% of actual escalation of
labour wages.
165
A question as to whether WPI is suitable for calculating
compensation for escalation of the construction projects and BCI is
appropriate index for calculating escalation payment was asked. The
respondent indicated their responses based on overall project experience. The
summary of the responses received from the respondent is shown in Table
7.7.
Table 7.7 Summary of responses in regard to whether WPI is suitable for
calculating compensation for escalation
Disagree Agree St
rong
ly
Mod
erat
ely
Slig
htly
Neu
tral
Slig
htly
Mod
erat
ely
Stro
ngly
(1) (2) (3) (4) (5) (6) (7) (8) (9)
WPI is not suitable for calculating compensation for escalation of the building projects
Client
66 no.
No. of resp 1 1 1 6 17 40
%ge 1.5% 1.5% 1.5% 9.1% 25.8% 60.6%
Contractor
53 no.
No of resp 1 - 19 33
%ge 1.9% - 35.8% 62.3%
Building Cost Indices are more appropriate index for calculating escalation payment for the building projects
Client
66 no.
No. of resp 5 10 51
%ge 7.6% 15.2% 77.3%
Contractor
53 no.
No of resp 1 11 41
%ge 1.9% 20.8% 77.4%
From table 7.7, the survey result shows that about 96% of the
client’s representatives and 98% of the contractor’s representatives are of the
opinion that WPI is not suitable for calculating escalation. Similarly, it is
166
clear that all contractor and clients representatives are of the opinion specific
building cost indices are a more appropriate index for calculating escalation
payment for the building construction projects.
Questions regarding satisfaction level of currently used escalation
clause in Government contracts was asked. The respondents indicated their
responses based on overall project experience. The summary of responses
received from the respondents is presented in Table 7.8.
Table 7.8 Summary of responses received from the respondent on
satisfaction level of escalation clause in contract
Respondent
Type Very High
High Average Low Very Low
(1) (2) (3) (4) (5) (6) (7) Satisfaction level of escalation clause in contract
Client 66 no.
-- 3 14 29 20
-- 4.5% 21.2% 43.9% 30.3%
Contractor 53 no.
-- -- 6 17 30
-- -- 11.3% 32.1% 56.6%
From Table 7.8, the survey result shows that about 89% of
contractor’s representatives and 75% of the client’s representatives are of the
opinion that their satisfaction level with the currently used escalation clause
in government construction contract is low. About 22% of client’s
representatives and 12% of the contractor’s representatives are of the opinion
that their satisfaction level is average. Only about 5 % of the clients
representatives are of the opinion that satisfaction level of currently used
escalation clause used in contract is high.
167
In the questionnaire, questions regarding the appropriate project
duration for consideration of escalation clause in the contract based on
overall project experience were asked. The summary of the responses
received from the respondents are presented in Table 7.9.
Table 7.9 Project duration for which the escalation clause should be
included
Respondent
Type > 3
months >6
months >12
months >18
months
All projects irrespective
of time
(1) (2) (3) (4) (5) (6) (7)
Appropriate project duration for inclusion of escalation clause in contract
Client
66 no.
13 40 9 1 3
19.7% 60.6% 13.6% 1.5% 4.5%
Contractor
53 no.
20 26 - - 7
37.7% 49.1% - - 13.2%
From Table 7.9, the results show that about 61% of clients
representatives and 50% of contractor representatives are of the opinion that
if the duration of the project is more than 6 months then, the escalation
clause can be considered.
Study of Wholesale Price Index In India: The compensation
under escalation clauses of CPWD, MES, TNPWD and all other government
contracts in India are based on the variation in wholesale price index. The
Office of the Economic Adviser, Department of Industrial Policy and
Promotion, Ministry of Commerce and Industry compiles and disseminates
weekly Wholesale Price Index (WPI) numbers on an all-India basis. The
broad break up of materials covered and weights under WPI index is shown
in
Table 7.10.
168
Table 7.10 Details of weights of various groups in WPI (Base 1993-94)
No. of items (Base 1993-94)
Weights (Base 1993-94
series) Group 1 Primary articles 98 22.025
Group 2 Fuel, Power, Light and Lubricant
19 14.22624
Group 3 Manufactured product 318 63.75
All commodities 435 100.00
From the above, it is seen that around 435 commodities are
involved in the groups which includes food items and many materials like
fertilizers, tobacco, papers, textile etc which are not actually related to the
construction activity. Further going into details on a selective basis, around
12% of listed commodities are likely to affect building industry directly or
indirectly and the balance have no impact. From this it is evident that the
compensation paid under escalation clause is not reflecting truly because it
covers 435 commodities which do not affect building construction industry.
WPI Vs. CPWD Cost Index: The Central Public Works
Department (CPWD) has been publishing the building cost indices since
1958. To study the relevance of wholesale price index into building
construction industry. The cost indices of WPI and CPWD from 1994 to
2005 were analysed and the same is shown in Figures 7.4 and 7.5.
169
0.00
50.00
100.00
150.00
200.00
250.00
300.00
350.00
Inde
x va
lue
Year
WPI CPWD Cost Index
Figure 7.4 WPI Vs. CPWD Cost index (1994-2007)
0.00
50.00
100.00
150.00
200.00
250.00
300.00
350.00
400.00
Inde
x V
alue
Month
Steel - Trend in WPI Vs. Actual Price Index
WPI
Actual Price Index
Figure 7.5 Steel – WPI vs Actual Market Price Index (1994-2007)
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7.7 FINDINGS IDENTIFIED AND RECOMMENDATION
The price variation clauses in government construction contracts in
India - details of the findings and recommendation are given below:
a) For Material Component: It is found that compensation paid to the
contractor based on the present escalation clause in government
contracts is not adequate to compensate for escalation in
Materials, Labour and POL. This is because the wholesale price
index is used in the formula for calculating the payment for
escalation. It is recommended that the indices of building cost
index should be used for calculating the escalation payment
instead of wholesale price index. Price escalation in material
components like steel, cement and brick etc. should be
reimbursed on actual procurement prices.
b) In government construction contract, major material components
like steel, cement are supplied by the clients. While, calculating
the escalation payment for components of material, labour and
POL, the material supplied by the client is deducted from the
overall cost of work. In reality when the cost of material supplied
by the client is deducted, the cost of handling such material also
gets deducted. Whereas in the calculation of escalation the cost of
handling materials supplied by the client should be added. In
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short the escalation clause should consider the labor and POL cost
of handling such material supplied by the client.
c) For Labour Component: In government contract, while calculating
labour escalation payment, minimum daily wage in rupees for an
unskilled adult male mazdoor is used. In reality the construction
industry today employs predominantly large skilled labor force.
Therefore while considering the escalation for labor component it
would be appropriate to consider the average daily wage for both
skilled and unskilled adult male mazdoor.
d) In government contracts there is no uniformity in terms of time of
contract for applying the escalation clause and it varies with the
organization. A single uniform standard period is not in vogue.
Escalation clause should be uniformly included in every contracts
where the project duration is more than six months.
e) Escalation during extended period of contract: The clause in most
of the government contract states that escalation is not provided
for extended period of contract. In Government contract, even if
the delay is due to the client, escalation payment is not provided
to the contractor. Escalation may be provided to the contractor for
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extended period of the contract, if the delay is from the client. If the
delay is due to the contractor’s actions, necessary penalty shall be
recovered from the contractor. One-sided conditions of contract
should be avoided.
f) Most of the government contracts have a one sided clause,
protecting only the interest of the clients. One-sided clauses in
contracts should be avoided. The current government contracts
forms have conditions that have not undergone any major change
in the last 150 years. These will have undergo major changes to
reflect the current day scenario. Government contract forms
should be reviewed and modified on the lines of world bank,
projects which are quite fair and equitable
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7.8 CASE STUDY OF SIX BUILDING CONSTRUCTION
PROJECTS IN INDIA
A brief overview of the building construction projects studied,
overall impact of “Escalation of materials, labour and POL components” in
each project and comparison of their impact with results of the survey
analysis is given in Table 7.12.
Table 7.11 Adequacy of compensation paid to the contractor based on
the presently used escalation clause in government contracts
in Indian Building Construction Projects
Adequacy of compen-sation paid
to the contractor
Building construction projects
Project name
Construction of
International Terminal Building
Construction of
Information Centre
Building
Construction of School
Building
Construction of
Residential Building
Construction of Hostel Building
Construction of
Residential Building
Type of contract
Item–rate Item-rate Item-rate Item-rate Lump sum Item-rate
Form of contract
CPWD MES MES CPWD CPWD MES
Impact of adequacy of compensation paid based on presently used escalation clause
Cement component
less than 60% Less than
45% Less than
45% Less than
60% Less than
60% Less than
50%
Steel Component
Less than 60%
Less than 40%
Less than 50%
Less than 50%
Less than 55%
Less than 45%
Other Materials
Less than 50%
Less than 50%
Less than 50%
Not considered
Less than 50%
Less than 50%
Labour component
Less than 50%
Less than 50%
Less than 60%
Not considered
Less than 60%
Less than 50%
POL component
Less than 50%
Less than 50%
Less than 60%
Not considered
Less than 50 Less than 60%
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7.9 SUMMARY
In India, CPWD is more than 150 years old and contract forms of
the CPWD form the basis of many other contract forms followed by other
Central and State Government Departments. CPWD has been used as a role
model for formulating the contract. Price variation clauses 10C, 10CA and
10CC have many drawbacks/ flaws. Some of the drawbacks in these clauses
are: for materials, Wholesale Price Index is not truly representating the actual
price rise in construction industry. Lack of Construction Cost Indices forces
the client to use Wholesale Price index for escalation payment. The labour is
compensated using Consumer Price Index which many times are less
compared to Minimum Wages. Escalation is not provided for extended
period even if the delay is due to the client. The material component is
deducted from all the components viz material, labour and POL which is not
fair. Rise in prices of materials like cement, steel, bitumen, explosive etc
should be reimbursed on actual basis on the basis of quantities used every
month as they form the major part of construction. This is now done in many
contracts.
A survey of client and contractor representatives was conducted to
study the adequacy of compensation paid to the contractor based on the
currently used escalation clause in government contracts and cost escalation
impact on the building projects in India. The survey showed that both groups
generally agree on the compensation paid to the contractor based on the
currently used escalation clause in government contract is not adequate for
the components of Materials, Labour and POL. The most important cause for
gap between actual escalation occurred and escalation payment made based
on currently used escalation clause in government contract is mainly due to
applying wholesale price index in the escalation formula for calculating
escalation payment. While most client representatives agree that cost
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escalation has impact on the quality of the project, the contractor
representatives donot agree with this. The survey showed that both client and
contractor representatives agree that escalation clause should be included in
the contracts where the project duration is more than 6 months. The survey
revealed that most client and contractor representatives are not satisfied with
the currently used escalation clause in contract and feel the need to improve
the currently used escalation clause in government contracts. The
respondents opined that cost escalation could impact the project schedule
and cause delays in project completion. The dissatisfaction with the
escalation provisions could cause dispute between clients and contractors.