Current approach to accommodate price variation in India is unrealistic and non-compensating. With the advent of contracting practices in the construction industry and the risk faced by contractors, reviewing the existing methodology of price variation and suggesting changes in the working process is of utmost importance. This paper attempts to lay down two alternatives for the traditional cost escalation formula for the Indian construction industry. While the traditional formulae in India and many other countries rely on the use of Wholesale Price Index (WPI) and Consumer Price Index (CPI) to calculate cost variation, the new approaches lay stress on the establishment of new indices known as construction cost indices, or using the market rate method for calculating escalation. This paper also tries to bring forth the various shortcomings in the existing methodology and suggests ways to avoid such inadequacies in the new approaches. The paper also emphasizes the use of these formulae in the international arena and provides a comparison of the methods to highlight the significance of new approaches.

Cost escalation is a change in the cost or price of specific goods or services of a given economy over a period of time. In a project, it refers to the additional amount of money required to construct a project over and above the original budgeted amount. Cost escalation occurs when the actual costs exceed previously estimated values. Determining the escalation cost to an estimate is often the subject of fierce debate.

Various organizations and companies in different countries adopt varying formulae linked with different price indices such as Construction Cost Index (CCI), Wholesale Price Index (WPI), Consumer Price Index (CPI), Producer Price Index (PPI) and many more based on local, social and economic situations in their respective regions. Joint work between the statistics directorate of the Organization for Economic Cooperation and Development (OECD) and the statistical office of the European communities (EUROSTAT) have conceptualized and developed indices in the development of construction price indices and released three types of indices: input price indices, output price indices and the seller price indices (www.oecd.org).

In India however escalation formulae are linked to a system of independent cost indices that allow the prices to be adjusted at determined intervals. These indices are evaluated by a representative basket of wholesale goods which is known as WPI. The purpose of the WPI is to monitor price movements that reflect supply and demand in industry, manufacturing and construction. The use of suitable escalation formulae linked ideally to a system of independent cost indices allow prices to be adjusted at determined intervals, thus limiting the clients’ and the contractors’ risk and attempting to give a fair and equitable return.

Infrastructure Journal, Indian Banks, Public Resources, Banking Sector, Commercial Banks, Infrastructure Projects, Gross Domestic Product, GDP, Corporate Financing, Project Financing Method, Credit Scoring Mechanism, Risk Assessment, Operational Risk, Organizational Structures, Infrastructure Development, Corporate Bond Market, Strategic Business Units, Indian Economy.