Impact of inflation on Construction

Contracts

Walaa R. Soliman
MEng., PMP
SR. QS/Cost Engineer – Hill International
Presentation Contents
1. Inflation in Construction
2. What is the Cost Escalation
3. How Cost Escalation is measured
4. Forecasting Escalation
5. Escalation Formula
6. Example
7. Benefits
Inflation in Construction
Introduction

Egyptian Construction Industry has a

significant increase in inflation during
the last 10 years which leads to a
major impact ongoing projects, due to
the obsession of some Construction
materials, recent governmental
legislation, fluctuation, fuel price
increase.
Inflation in Construction
Consumer Price Index
Average consumer prices inflation
rate
• During 2018, inflation rate for Egypt
was 20.9 %. Though Egypt inflation
rate fluctuated substantially in
recent years, it tended to increase
through 1999 - 2018 period ending
at 20.9 % in 2018.
Inflation in Construction
Inflation in Egypt Up-to
2018 DATE VALUE CHANGE, %

2018 20.9 -11.37 %

2017 23.5 130.78 %

2016 10.2 -7.23 %

2015 11.0 8.88 %

2014 10.1 46.04 % https://knoema.com/atlas/Egypt/Inflation-rate

2013 6.9 -20.07 %

2012 8.7 -22.00 %

2011 11.1 -5.13 %

2010 11.7 -28.02 %

2009 16.2 38.83 %

2008 11.7 6.74 %

2007 11.0
What is Cost Escalation ?
• Cost Escalation refers to the
anticipated increase or
decrease, over a defined
period.
• Building cost increases usually
occur as a result of market
forces, and reflect increases in
the cost of Material,
equipment and labor.
What is Cost Escalation ?
Inflation What Should You Carry?
• When construction is actively growing,
total construction costs typically
increase more rapidly for labor, materials
and equipment. Accordingly the
overhead and profit increase as % of the
dry cost.
• To properly adjust the cost of
construction over time you must use the
actual indices for this given period.
How Cost Escalation is Measured?
• Escalation/Inflation is measured by
the consumer price index which
reflects the annual percentage
change in the cost to the basket of
goods and services that may be
fixed or changed at specified
intervals.
• The Escalation formula is generally
used by using the averages indices
for the year, every 3 months, not
end-of-period data.
Forecasting Escalation
Tender Phase Contract Award Contract Completion

Tender Phase Escalation Contract Phase Escalation

Tender phase escalation Contract phase escalation (Post Contract)

Requires the identification of the following fundamental • Where it is likely that costs will increase during the
factors: contract phase, an allowance should be included
• Date the estimate was produced. for cost escalation between the expected tender
• Expected Contract award date. date and the expected date of practical completion
• Estimated escalation rate (as a percentage of the cost
estimate per year)
• The time between the tender pricing and Contract
award.
Forecasting Escalation
When to Apply Price Adjustment
• The risk of price escalation is likely to arise:
(i) for goods contracts with long delivery periods;
(ii) for works contracts with long completion
periods;
(iii) for major civil works/MEP contracts;
(iv) for contracts that contain supplies or
commodities whose prices fluctuate
significantly over a short period;
(v) for time-based consulting services, such as
construction supervision services
(vi) due to any unusual/unexpected circumstances
in the market in question.
Forecasting Escalation
When Not to Apply Price Adjustment
i. The procurement of certain
types of equipment which may
be the case for : Engineering,
procurement and Fixed-price
contracts.
ii. Contracts for the supply,
installation, and construction of
facilities wherein the permanent
works represents the major part
of the estimated cost of the
contract.
iii. Simple supply contracts with
short delivery periods.
Escalation Formula

• Provision in a contract for increasing or

decreasing the contracted price for labor,
material, etc., in step with the market
prices or an agreed upon benchmark such
as consumer price index (CPI).
Adjustment for changes in Contracts
FIDIC reference for the adjustment formula sub-clause 13.8

Pn= adjustment multiplier to be applied to the estimated contract value in the

relevant currency of the work carried out in period n, this period being a month
unless otherwise stated in the Contract Data;
a = fixed coefficient, stated in the relevant table of adjustment data, representing
the non-adjustable portion in contractual payments;
b, c, d, etc. = coefficients representing the estimated proportion of each cost
element related to the execution of the Works, as stated in the relevant table of
adjustment data; such tabulated cost elements may be indicative of resources
such as labor, equipment and materials;
Adjustment for changes in Contracts

• Ln, En, Mn , etc. = current cost indices or reference prices for period
―n, expressed in the relevant currency of payment, each of which is
applicable to the relevant tabulated cost element on the date prior to
the last day of the period (to which the particular Payment Certificate
relates);
• and Lo, Eo, Mo, etc. = base cost indices or reference prices, expressed
in the relevant currency of payment, each of which is applicable to
the relevant tabulated cost element on the Base Date
Example
FORMULA

P= 0.65529 + 0.079 (Ae/A0) + 0.2157 (Be/B0) + 0.05 (Ce/Co)

Fixed Coefficient for the Bulk Cement Reinforced steel Diesel

non-adjustable portion Coefficient Coefficient Coefficient
65.53% 7.9% 21.57% 5%

0.6553 0.079 0.2157 0.05

And as per the agreed Contract provisions the base date

will be Feb 2016, certified amount during the period Jan
2017 was 1,000,000 EGP
Example

Feb-16

BASE COST INDEX BASE COST INDEX BASE COST INDEX

DESCRIPTION FOR BULK CEMENT FOR STEEL R.F.T. FOR DIESEL
A0 B0 C0

This indices based on

CAPMASS during the 253.300 189.9 289.6
Contract date
Example

Jan -17

BASE COST INDEX BASE COST INDEX BASE COST INDEX

DESCRIPTION FOR BULK CEMENT FOR STEEL R.F.T. FOR DIESEL
Ae Be Ce

Application of
Adjustment Formula 221.1 437.7 542.3
Based on CAPMAS
Example
Adjustments for Changes in Cost by using coef. For Feb 2016 to Jan 2017

Feb-16 Jan-17

BASE COST BASE COST Estimated Net Amount

DESCRIPTION INDEX FOR BASE COST BASE COST BASE COST BASE COST P work to Inflation Change in Cost
INDEX FOR
INDEX FOR INDEX FOR INDEX FOR INDEX FOR Complete K
BULK BULK
STEEL R.F.T. DIESEL STEEL R.F.T. DIESEL
CEMENT CEMENT
B0 F0 Be F0
A0 Ae

Application
of
Adjustment
Formula
253.300 189.9 289.6 221.1 437.7 542.3 1.315
1,000,000 1,315,052 315,052
Based on
CAPMAS
Example

Then the Contractor is entitled to a

change in costs according to the
above illustrated table with amount
equivalent to 315,052 EGP, and
accordingly the contractor’s
payment certificate will be
1,315,052 EGP
Benefits of applying the Adjustment
Formula
• Simplify the identification of outdated
allowances for cost escalation
• Facilitate improved understanding of how
allowances have been calculated
• Improve communication regarding the status
of allowances,
• Reduce the risk of having to seek approval for
further funding for the project
• Enhance transparency and accountability with
respect to budgets for government building
projects.
 - https://knoema.com/atlas/Egypt/Inflation-
rate
wala2a@hotmail.com - The State of Queensland (Australia)
(Department of Housing and Public Works)
- FIDIC Red Book 1999