Wholesale Price Index and its effect on Price Escalation of materials for Indian construction industry

Wholesale Price Index and its effect on Price Escalation of materials for Indian construction industry

Dr. N. B. Chaphalkar

Associate Professor, Depart ment of Civil Engineering, College of Engineering, Pune- 411005, Maharashtra, India.

Ms. Sayali S. Sandbhor

Post Graduate Student, Depart ment of Civ il Engineering, College of Engineering, Pune- 411005, Maharashtra, India. E-ma il ID:

Abstract

For defining economy of the country, units contributing to it viz. goods and services traded in the economy are supervised indicated through various indices drafted by concerned authorities on the basis of retail, wholesale or producer prices of the goods. Indian economy follows wholesale price indices (WPI) compiled at national level which is a measure of wholesale price movement for the economy. Escalation with reference to construction industry is one of the major dispute prone clauses. Standard Indian construction contract conditions provide for calculation of escalation amount for materials using relevant WPI. Amount of change in WPI over a span of time affects the amount of escalation calculated. This paper studies the current structure of calculation of wholesale price index, identifies construction materials considered in the commodity bask et, variation in WPI of these materials and its effect on arriving at escalation amount.

Keywords: Escalation, price indices, construction materials

1. Introduction

   The economy of India is the twelth in the world by nominal GDP and the fourth largest by purchasing power parity with share of global GDP of 5.84%. In India, the highest growth rate was recorded in the mid-2000s, and is one of the fastest-growing economies in the world. Large instability e xists in an economic system. Th is

   instability reflects in adverse effect on prices of commodit ies. Thus variations in economic conditions are needed to be monitored. A statistical measure to assess changes in the economy is provided through various indices. In a financia l ma rket, an inde x is an imaginary portfolio of commodit ies representing a particular ma rket or a portion of it.

   With the advancement of science, technology and increase in industrialization, the demand for developmental projects has increased. Major outlay of the budget is spent on construction industry, hence it is of utmost importance to have close control on its cost and time management while achiev ing quality standards for the construction projects. Construction sector largely depends upon resources such as materials, mach inery and labour which are the ma jor cost drivers of construction projects. Variations in costs of these items of work as a result of variation in overall economy of the nation, affects the budget of a construction project adversely. This price rise is referred to as escalation in construction contract documents. The relation between escalation and related price indices is studied in this paper.

2. Price escalation

   Escalation is a phenomenon of economics reflected through rate of inflation computed fro m WPI data. Escalation is the change in cost or price of specific goods or services in a given economy over a period. Inflationary trends in economy get reflected through escalation in prices of units. It is the increase in the cost of any construction ele ments of the origina l contract or base cost of a

   project due to passage of time [10]. John Hollmann et. al. (2007) [8] defines escalation as changes in price levels driven by underlying economic conditions.

   Escalation affects the budget and causes severe financial overrun by the contractor. It also adds to contingency in the contractors bid and is a ma jor contributor to the overall cost uncertainty of escalation in h is tender rates from the e mp loyer. Construction work is carried out according to the pre-confirmed contract agreement. To cope up with the sudden price escalation, regulated provision is necessary in construction contract document.

3. Construction contract and claims

Contract terms and conditions play a dominant role in proper and time ly e xecution of works, preventing and resolving disputes arising thereto [7]. Conditions of contract guide the involved parties regarding their rights, obligations, responsibilit ies and procedures to be followed. Draft ing a construction contract is nothing but allocation of risks involved in a project among the parties to the contract [5]. Irrespective of all the provisions in the contract document, claims are raised on a construction site. Cla ims generally arise when one party to the contract suffers a detriment for which that party needs to be compensated by the other party [9]. It may be defined as a legitimate request for additional compensation on account of a change in the scope of project. Possibility of escalation over the period of e xecution of project leads to claim for escalation amount in addition to the base cost. Claims when not properly sorted lead to disputes .

To cope with the possibility of changes in economic conditions reflected through fluctuation in the cost of ite ms and to ma ke a prov ision for fair re imburse ment of the escalation cost to the contractor who bears the extra cost, regulated escalation clause in the law or conditions of construction contract is necessary. Construction contract conditions drafted by central public works department (CPWD), India, contain provis ion for calculation of escalation in prices of construction materia ls for co mpensating the contractor.

1. Price index

   The price index is an indicator of the price move ments of fixed basket of commodities over time. A cost index provides a comparison of cost or price changes fro m period to period for a fixed

   the project execution especially in projects in which variability and uncertainty is greater. Due to frequent rise in the prices of materials and wages of labour, the contract rates of the various items of work a re affected adversely for the contractor who could not visualize such a steep rise and therefore could not include the same in his tender rates. Under such circumstances, the contractor claims quantity of goods or services [11]. Rate of inflation is an important measure to monitor economic fluctuations which is based on the move ment of these indices. Rate of inflation is the rate at which the general level of prices of goods and services rise. Inflation is a continual increase in prices throughout a countrys economy. The behaviour of the economy is cyclical and hence the pattern of change in the indices cannot be estimated accurately. Va rious price indices followed by different countries are wholesale price inde x (WPI), producer price inde x (PPI), consumer price inde x (CPI). As the name suggests, WPI considers prices of goods at wholesale level, PPI at the producers end and CPI at consumer level.

2. Wholesale price index (WPI)

   WPI is an index that measures and tracks the changes in price of goods in the stages before the retail level i.e . at the wholesale market level [2]. Govern ment of India uses wholesale price inde x to monitor the changes in the average price level of goods traded in wholesale market fro m period to period. The purpose of WPI calculation is to monitor p rice movement serving as an important determinant in formu lation of economic policies of the nation. Th is inde x is used for the purpose of escalation clauses in the supply of materia ls and mach inery in construction works [1]. WPI is calculated on the basis of quotations of various items rece ived at a regula r interval of time . The ite s to be considered for calculat ion are decided based on market study, demand, supply, consumer behaviour etc. In India, since January 1942 i.e. introduction year of WPI, the series has undergone number of constructive changes.

3. Need of revision of the series of WPI

As stated earlier, economies undergo enormous changes over time. Libera lizat ion in India has added to it which is quite evident from the pace of these changes. As a result of this, the ma rket keeps on changing and updating with addition of newer materials and re moval of

obsolete ones. A relatively fixed set of consumer products and services valued on an annual basis to track inflation in a specific market or country is a commodity basket. Thus the changes need to be incorporated in the commodity basket for the computations for WPI to be more effective, precise and indicative of the present economic

situation. History of WPI in India is representative of this phenomenon with overall seven revisions of the series of commodit ies to incorporate the dynamic changes in ma rket. It has been a practice since then to revise the series after every decade. The revisions in WPI series in India till date are compiled in Table 1 be low.

Table 1. Revisions in WPI series in India

Hence, the commodity basket is tentative. Some o f the ite ms may have to be deleted, and the nomenclature of some of the ite ms may have to be altered or new ite ms may have to be included, depending on the availability of prices for the ite ms selected for the new series basket and findings of the field survey on the nomenclature used in the new product basket [3].

3.0. Calculation of WPI

Each inde x has its own calculation methodology and definition of terms and is e xpressed in terms of a change from a base value. The commodity basket forms the basis of computation of WPI as it is said to represent the overall ma rket. Once the basket is fixed, transactions of the items in the basket in a given economy are surveyed and recorded. Price quotations for the same ite ms are co llected fro m various vendors . Based on this information further calculations are carried out as follo ws.

Allocation of weights

Value of output is the value of transactions carried out in domestic market at first point of bulk sale. Weights are assigned to the commodity on the basis of its share in the total value of output in the economy. The weights of individual co mmodit ies

are represented as a percentage of total value which when summed up equals 100. These weights are used in calculation of inde x for a ll co mmodities. For ite ms added newly, we ights are revised for e xisting ite ms. Weights of ite ms to be removed are adjusted among other group me mbers.

Calcul ati on of price relati ve

Prices are collected for those ite ms which a re selected in the WPI basket from selected sources for data collection. M inimu m 5 quotations per ite m are desirable whereas lesser number due to unavoidable circumstances is also acceptable. Price relative is the ratio of current price and base price of the commodity. Price re lative is calculated for each quotation. Price quotations for commodit ies enable calculation of price relat ive which is calculated as follo ws:

Price re lative = (Current price/ Base price )*100

Calcul ati on of Index

Average of price relatives for all quotations for a given commodity gives the WPI for that particular ite m. Method of compilation of inde x follows Lasperyres formu la based on weighted arith metic mean wh ich is as follows:

I =((IiXWi)) / (Wi)

Where,

I = Inde x nu mber of wholesale p rices of a subgroup/group/majo r group/ all co mmodit ies

Ii = Inde x for ith commodity in the subgroup/group/major group

Wi = Weight assigned to the

ite m/subgroup/group/major group within the subgroup/group/major group/basket.

1. Materials in commodity basket

   Co mmodity basket, as the name suggests, is a basket comprising of all co mmodities selected for calculation of WPI. It is basically a subset of products that is designed to mimic the performance of an overall market. The goods in the basket are often adjusted periodically to account for changes in consumer habits. Series 2004-05 contains total 676 ite ms against 435 ite ms in the previous series 1993-94. 259 ite ms are co mmon a mong these series. 176 ite ms out of total 435 fro m series 1993- 94 a re deleted and total 417 new ite ms are included in the commod ity basket of series 2004-05.

   In series 2004-05, goods are divided into

   Weight

   three ma jor groups viz. primary art icles, fue l & power, manufactured products. Primary art icle group is divided into three subgroups of food

   articles, non-food artic les and minera ls wh ile manufactured products group is divided into 12 subgroups of food products, beverages, tobacco & tobacco products, textiles, wood & wood products, paper & paper products, leather & leather products, rubber & plastic products, chemica ls and chemical products, non-metallic mineral products, basic meta ls alloys & metal p roducts, machinery and mach ine tools, transport equipment & parts.

2. Construction items in commodity basket

As per the study, there are 51 total construction materia ls identified in series 2004 -05 out of which 15 are co mmon between series 2004- 05 and series 1993-94. 10 construction items are deleted from series 1993-94 whereas 36 new ite ms are added in the latest series. Total of the we ights allotted to these 49 ite ms in the latest series is 8.92431 with the major construction materials/ equipment like steel flat-HRC 1.39672, grey ce ment having1.26347, 0.73617 for rebars, 0.40622 for rounds (long steel), 0.34117 for bricks & tiles and as low as 0.01417 for lime, 0.0129 for loader, 0.00777 for distemper. Fo llo wing graph shows the weights allotted to these construction items.

1.4

Weight

1.2

1.0

0.8

0.6

0.4

0.2

0.0

Commodity

Bitumen

Wooden planks

Timber posts/squares

Plywood board

Insulation board

Veneered particle board

Veneer wood

Plastic/ PVC pipe

Paints

Chemical colours

Lacquor and varnishes

Distemper

Thinner

Bricks & tiles

Polished granite

Marbles

Stone

Laminated glass

Fibre glass & glass sheet

Toughened glass

Non-ferrous sanitary fittings

Grey cement

White cement

Slag cement

Lime

Graphite rods/p>

Asbestos corrugated sheet

Railway sleeper

Concrete poles & posts

Hume pipes & spun pipes

Other cement products

Steel- long rebars

Steel-rounds

Steel-wire rods

Steel-angles

Steel-joist & beams

Rails

Steel-flat HRC

Steel-plates

Steel-CRC

GP/GC sheets

Steel pipes- welded pipe

Cranes

Lifts

Pump & assembly

Loader

Concrete vibrator & mixture

Other construction machinery/ equipment

Light diesel oil

Lubricants

Earth moving machinery

Fig 1. We ight allot ment to various construction items identified in WPI co mmodity basket

5.0. Variation in WPI for major construction materials

Change in WPI over time is the phenomenon of economy. The variation in economic conditions is reflected through changes in WPI. Over the past few years construction industry has witnessed boom. Th is is also

reflected through significant increase in WPI for ma jor construction materia ls. The following table highlights this variation in WPI for eight financia l years. Fig 2 & 3 ind icate the monthly variation in WPI for co mmod ities grey cement and rebars from January to December for the year 2011.

Table 2. Yearly variat ion in WPI for ma jor construction materials

WPI

WPI

162

161

156

154

150

147

Apr

Aug

Dec

Apr

Aug

Dec

Month

Month

WPI

WPI

Fig 2. Monthly variations in WPI for g rey Fig 3. Monthly variations in WPI for rebars ce ment

1. Escalation calculation by CPWD formulae

   CPW D provision for escalation in clause 10CC [4] allows for estimation of escalation amount using different formulae for diffe rent components of construction such as labour, materia l, ce ment and steel, P.O.L. Standard formula for all these components is as follows:

   V= W * X * CI-CIo

   —– ——–

   100 CIo

   Where,

   V = variation in cost of ite m i.e. increase or decrease in the amount in rupees to be paid or recovered.

   W = cost of work done for the period to which escalation is applicable

   X = component of item e xpressed as percentage of

   total value of work

   CI = All India Wholesale Price Inde x for ite m for period under consideration as published by Economic Advisor to Government of India , Ministry of Industry and Comme rce.

   CIo = All India Wholesale Price Inde x for ite m as valid on the last stipulated date of receipt of tenders including e xtensions, if any (base inde x) .

   Consider, sudden escalation is encountered in Nov2011 on a construction project in which work of INR 2,00,000 is executed in this period and quantity of grey cement accounts for 40% of the work and the base i.e. CIo is taken as Jan2011 for grey cement. Then the escalation amount to be recovered fro m the owner co mes out to be INR 6977.68. If the same is encountered in the month of Dec2011, the a mount comes as INR 7302.23.

   Hence, any variation in WPI fro m date of

   receipt of tender to the date of actual computation is directly proportional to the variat ion in cost of ite m to be recovered under escalation.

2. Case study

Escalation is one of the most dispute prone clauses in construction contracts as per the study of Iyer and Kalidindi (2002). Various claims related to escalation were studied. One of the claims was raised on a project of lining of left bank canal which followed CPWD conditions of contract. Claim was for balance payment of price escalation amount. For working out the amount of compensation, the base inde x to be adopted was the average index fo r the quarter preceding the date of opening the tender as specified in contract document. Hence there was amb iguity in considering the value of CIo as shown in the formu la above.

The owner had adopted different meaning of quarter and had taken indices of three months prior to date of opening i.e. of month June. No definit ion of term quarter was provided in GCC, hence definit ion in common parlance should have been adopted i.e. 1/4 th of a year. A s the bids were opened on 27/9/1994, quarter preceding it would have been April-May-June. Hence, the contractor claimed for the difference of INR 5,00,681. Taking WPI for ca lculations as the average of WPIs for the months April-May-June instead of June as was calculated by the respondent, the difference of amount payable to the contractor came out to be INR 5,00,681. The contractors case was found to be genuine and hence this amount was granted to the contractor.

This shows that WPI varies in a very short time span and affects the amount computed using escalation formula.

1. Findings and s uggestions

2. Findings

   1. Fro m the total of weights allotted to the identified construction items, it is seen that as per series 2004-05, construction items account for approximately 9% of the total econo my. Series 1993-94 allots 5.5% of the we ights to construction ite ms. Hence there is drastic rise of 3.5% in the weightage of construction items fro m old to revised series.

   2. Among the various materia ls and machinery considered in the commodity basket of series 2004-05, it is observed that flat HRC steel has the highest weight followed by grey cement and steel rebars. Major ite ms affect ing the price of work a re identified as cement and steel which consume higher we ights and affect the overall cost of the work e xecuted. Ite ms such as bricks & t iles, paints, various types of steel items also consume considerable we ights.

   3. In series 1993-94, co mmodit ies such as building bricks, cera mic tiles, fire bricks we re considered as separate entities. But as the individual weights assigned were very low these commodities are now grouped in series 2004-05 forming one commodity of bric ks & tiles. Ce ment was a separate entity in series 1993-94 with 1.73105 weight whereas this entity is divided into four separate commodit ies of grey cement, white cement, slag cement, lime under the heading cement & lime in series 2004-05.

   4. Under the subgroup of machinery & machine tools, separate provision for construction mach inery has been made which takes into account major constructio machinery such as loader, concrete vibrator & mixture and other construction machinery / equipment. Co mmodity other construction machinery / equipment is supposed to take into account all the rest mach inery which are not separately given weightage in the series. Earth moving machinery though majorly imp le mented on construction works is included under the heading non-electrica l mach inery rather than construction machinery. There was re moval of co mmodity e xcavator fro m mach inery in series 1993-94 wh ich was given weightage of 0.10637.

   5. Items such as tractor, trucks, diesel, lubricants, safety helmets, hydraulic & pneu matic tools, compressors etc are given weightage in WPI series based on their overall transactions in the ma rket. These items consume a considerable portion of budget on construction sites. Considering their overall we ight for calculation of escalation is rid iculous as only percentage of these items would have been consumed by

      construction sector and only this percentage should affect the computation of escalation.

   6. Variation in WPI e xh ibits a typical trend of increase over years. For some materia ls this variation is either gradual o r drastic. Va riation on the negative side may also be encountered with some materia ls whose market rate falls in course of time . Th is is indicat ive fro m va lue of WPI for stone for the year 2007 & 2008 and that for rebars for the year 2009 & 2010. There was negative change observed in WPI for bitumen in the year 2011 whereas it experienced a drastic increase in WPI in the month of January2012.

   7. These ups and downs in the values of WPI of the construction materials directly affect the a mount of escalation derived from the formulae for diffe rent components of construction given in clause 10 CC of CPWD conditions of contract. The most important cause for the gap between actual escalation occurred and escalation payment made based on the currently used escalation clause in the CPWD contract is ma inly due to the application of the WPI in the escalation formu la for calcu lating the escalation payment.

3. Suggestions

1. Products such as rubber transmission belt, V be lt, plastic cabinet, pencil, dried tobacco, cotton pillow cover etc. which consume very less weightage approximately of the order of 10-², a re included in the commod ity basket. It is important to include sand, being one of the most important commodit ies utilised on construction sites, as one of the commodity in the series.

2. All the construction related items should be grouped under one sub-group for ease of calculations as it is provided for rubber and textile industry. For ite ms such as tractor, trucks, diesel, lubricants etc. which are given we ightage in WPI series based on their overall transactions in the ma rket, a percentage figure should be provided which would represent the share of construction sector in the total we ightage of the commodity.

3. Efforts should be made to source the data of

   commodit ies and their quotations from different parts of the country in order to have a variety of data. This would ma intain geographically balanced character of the wholesale price inde x thus ma king it more appropriate.

4. WPI varies in a very short span of time and hence the amount calculated using the formu lae is time sensitive. Base month to be considered in the computation of WPI for any particula r materia l should be fixed and accepted by both the

   contracting parties. The month or quarter in which escalation in prices was observed should be clearly identified and accepted.

5. As seen from the statistics, construction items in the latest series account for approximately 9% . Considering unwanted 91% of ite ms which have got no relation with the items under consideration affects the escalation amount payable. Hence using WPI is irre levant in calculating escalation amount for construction materials.

6. As WPI is calculated based on the prices at wholesale level, it does not depict the exact ma rket situation, hence switching to a better inde x such as PPI or CPI would be benefic ia l as price changes from producers and consumers prospective are more re levant and technically superior co mpared to one at wholesale level. Th is should be taken into account by CPWD in revising the contract conditions.

7. A separate index for construction items such as

   building cost index (BCI) should be drafted and adopted. Use of BCI for escalation calculation would be more appropriate as it would consider the effect of construction related items only. Be ing a specialised inde x, many construction related ite ms which are not included in WPI series due to their very less or negligible weightage can be accommodated in the series of BCI.

8. Considering the emerging new technologies in construction industry, new materia ls such as alu min iu m formwork, fe rroce ment, roofing te xtile fabrics, paving blocks etc., need to be given due consideration in revising the series. Revision of series should be exerc ised yearly so as to consider the effect of new technologies, new materia ls coming in the market.

8.0. Conclusion

The WPI which is considered for calculation of escalation for c ivil engineering ite ms co mprises of basket of materia ls which contain approximately 91% of materials those are not directly related to construction field. The co mpensation paid to the contractor based on the currently used escalation clause in CPWD contracts is not adequate as it considers WPI for its computation. Hence it is quite evident that the escalation calculated using WPI may not reflect the correct increase and may be unjust to either owner o r contractor. Hence there is a dire need to develop an index wh ich is e xclusively useful to the construction sector which is second largest industry in India. This study highlights the need of such index.

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