Escalation clause and calculation in construction contracts ?

www.civilengineeringroles.com May 01, 2020

What is the escalation clause in construction contracts?

Escalation means increase(or decrease) in the cost of cement, steel, labour, fuel & power, machinery and other commodities due to fluctuation to any cost based on market condition. This clauses generally included in large contracts where lots of materials will be used and their period of execution is more than one year.  




Without the price escalation clause that allows for an adjustment to the contract price, if there is an unexpected rise or decrease in the market price of construction materials, a contractor will have no respite from such inflation. Therefore, it is necessary to have an escalation clause in the contract to guard against a sudden increase(or decrease) in the cost of materials. 

Further, it may be noted that escalation clause shall be applicable to those items which are under the scope of the contract as per the accepted Bill of quantities (BOQ) and do not apply on extra items.


What happens, if escalation clause is deleted from the contract?

  1. The escalation clause works for ways (Increase and decrease). So, there's the potential to include de-escalation provisions that will lower the price if the cost of materials drops. Those situations can really create a win-win and fair allocation of risk. 
  2. The contractor takes an extra contingency amount at the time of bidding to reduce the degree of risk may arise due to escalation if the contingencies are overestimated, the probability of the contract being awarded to another contractor. Accordingly, it necessary to consider the escalation clause in the contracts.
   The escalation clause is used in the contract to avoid cost overrun by the contractor and reduce the contingency amount in the contractor's bid. 


What items/components are subject to an escalation clause?

It depends upon the contract to contract. However, the most common are listed below:-

1) Steel
2) Cement
3) Labour
4) Fuel & Power
5) Machinery & Tools

Important terms and resources to be remembered while calculating the escalation in construction projects:-

1) Price indices:- 
Steel, Cement, Labour, Fuel & Power and machinery  & tools indices are issued or published by the Central Public works department (CPWD) and Whole Sale Price index, as published in the RBI Bulletin.

2) Base Period or Base year:-
Base period refers to the benchmark where economic data from other period measured. For example, if the price index has the base year of 1990, the current price is being compared to the base year.

3) Linking factor:-
The linking factor applied to convert base year to the desired base year. For example, CPWD issued the linking factor for conversion of Oct 2007 base year to Oct 2012.
Related: Linking factor  for the cement and steel as published by CPWD

4) Formula to calculate Escalation in construction projects:-

 Escalation= (Work done) * (Component percentage) * {(Current rate - Base rate) / Base rate}

 Escalation:- With the help of the aforementioned formula, we can calculate the escalation separately for steel, cement, Fuel & power and machinery & tools.

 Work Done:- Monthly RA bills amount excluding the extra items.

Component Percentage:- 
Steel- 25% , Cement-15% , Labour-22% , Fuel & Power-5%  and Machiner & Tools-18%

 Current Rate or Current month - Price indices issued or published by the Central Public works department (CPWD) and Whole Sale Price index, as published in the RBI Bulletin for above five components fo the current months.

 Base rate or base month - Price indices issued or published by the Central Public works department (CPWD) and Whole Sale Price index, as published in the RBI Bulletin from date of Letter of Intent or Notice to proceed.

 Download: Escalation working for the steel, cement, labour, Fuel & Power and machinery & tools

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