FinMin urges shift to Producer Price Index for price escalation in government contracts

The finance ministry has nudged all ministries and departments to move to Producer Price Index (PPI), from the current Wholesale Price Index (WPI), for rate escalation and adjustment clauses in future government procurement contracts.

The Department of Expenditure, in a communication to all ministries and departments, said that PPI is a more internationally accepted index compared to WPI used in government contracts to define price escalation.

For the first time, the commerce ministry has started issuing monthly PPI data for both goods and services since June to better reflect price movement at the producer's level, thus paving the way for phasing out wholesale price inflation numbers in the next five years.

"Ministries/Departments are encouraged to adopt Producer Price Index (PPI) in place of Wholesale Price Index (WPI) in all price escalation clauses of future contracts, once PPI becomes available," the expenditure department said in an office memorandum dated July 13, which was sent to all ministries.

The price escalation or rate variation clause in government contracts allows payments to be adjusted in line with changes in the cost of key inputs, such as materials, labour and fuel, during the execution of a project. It helps distribute the impact of inflation between the government and the contractor.

The launch of monthly PPI data is in line with practices adopted by advanced economies and follows the recommendations of the International Monetary Fund (IMF), which stressed that India needs to transition from WPI to PPI.

The output (goods) PPI cover all representative goods transacted in the economy. Manufactured items have the highest 69.93 per cent weight in output PPI (goods), followed by agriculture, forestry and fishing (22.16 per cent), electricity (4.49 per cent), and mining and quarrying (3.42 per cent).

Seven services -- banking, securities transaction, insurance, management of pension funds, railways, air (passenger), and telecom -- have been covered in the first phase of Service PPI, while remaining services will be covered in the next phase, the Commerce and Industry Ministry had said while launching the PPI data in June.

In the case of Service PPI, no weights are being assigned, since the seven services does not cover the entire service sector