Shams Engineering Journal 12 (2021) 407—414

Ain

Impact of inflation rate on construction projects budget: A review Check for

updates
Muhammad Ali Musarat, Wesam Salah Alaloul * , M.S. Liew
Department of Civil and Environmental Engineering, Universiti Teknologi PETRONAS, Bandar Seri Iskandar, 32610 Tronoh, Perak, Malaysia

ARTICL ABSTRACT
EINFO
Owing to its significant contribution to GDP and other sectors, the
construction industry plays an important role in economic growth. The
Article history:
Received 7 October
economy of countries depends on a number of variables in which inflation is
2019 one of them. The position of inflation in economic growth cannot be
Revised 29 February overlooked, as it is retaliating either positively or negatively. This paper
2020 explores the role of inflation and how it affects the economy and the
Accepted 13 April 2020 construction industry. It is concluded that the inflation rate is neglected in
Available online 15 most of the construction projects economics and budgeting that causes the
June 2020 project cost overrun as the building materials prices, labour wages, and
machinery hire rates are changing annually. Moreover, a framework has
been proposed that highlights the strong relationship between the inflation
Keywords:
Construction industry
rate and the construction industry. The framework is useful for the future
Economy
budget estimation model to eliminate project cost overrun which occurs due
Inflation rate
to the inflation rate.
Budget estimation 0 2020 The Authors. Published by Elsevier B.V. on behalf of Faculty of Engineering,
Ain Shams University. This is an open access article under the CC BY-NC-ND
license (http://creativecommons.org/licenses/by-ncnd/4.01).
1. Introduction as indexed by Scopus [12]. Fig. 1 illustrates the
inflation research numbers conducted from the
Inflation is seen as a crucial variable for potential year 1945 to 2018.
economic conditions, where sustainable economic
growth is a primary goal of every nation [1,2]. The Fig. 1 demonstrates the pattern of inflation
shift in inflation rates is a challenge to calculate and research showing its significance in the economy.
track monetary policy analysis on time, and any In 2018, 3628 documents were published
resulting ambiguity is a sign of the incredibility of indicating the maximum number of publications.
policy decisions [3]. Whereas reliable inflation rate In the early 1900s, some work was done on the
forecasts are important for monetary policy [4]. inflation rate, but from 1969 onwards, due to
Various factors should be considered to assess and market influence and demand in the industry, it
monitor the impact of inflation levels, such as interest gained momentum in the field of inflation
rate, potential output, exchange rate, money supply, research. Till today, the inflation research
wage rate, trade openness and expectations [5,6,7,8]. continues for the betterment in the economic
At the same time, the purchasing power of money
never remains stagnant, which indicates the importance growth and inflation rate effect on the industries.
of inflation in the economic world [9,10]. Prichett et al. In the world, one third of countries rely on primary
[11] defined inflation as: "a rise in the price level of a resources, i.e. food, mineral and energy products, as a
good or service or market basket of goods and/or major source of income [13,14,15,16]. Investment
services". decisions and consumption are influenced by inflation
expectations and, above all, by the determination of
Inflation has been known for a long time due nominal interest rates [17]. Inflation is important in
to its vibrant impact, and since 1945 it has also determining the firm's liquid asset holdings, and any
been regarded in research field, difference in inflation also affects the value of the
firm's liquid asset [18].
Nusair [19] conducted a study on Gulf
Cooperation Council countries to assess the
* Corresponding author. impact of changes in oil prices on inflation. The
E-mail address: [email protected] (W.S. Alaloul).
Peer review under responsibility of Ain Shams University. study shows the various effects on
inflation by rising and falling oil prices,
where it was evident that the rise in oil
ELSEVIER Production and hosting by Elsevier prices had a positive impact on inflation.

https:/Idoi.org/l O. 1016/j.asej.2020.04.009
408 M.A. Musarat et al./Ain Shams Engineering Journal 12 (2021 ) 407—414
Whereas, the frequency of creative destruction is estimated budget, which leads to the revision and
reduced due to price fluctuations which reduce ends up the project for cost overrun. This effect is
the recompense for innovation [2]. attributed to the annual revision of the building
The inflation rate also has an effect on the materials prices, labour
construction industry and affects the project's
2090-4479/0 2020 The Authors. Published by Elsevier B.V. on behalf of Faculty of Engineering, Ain Shams University. This is an open access
article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.O/).
4000

3500

3000

2500

2000

1500

1000

500

Fig. 1. Documents by year on inflation (1945-2018) [121.

wages and machinery hire rates, which is causing resulting in increased pressure on scarce
serious distress among the stakeholders. Keeping resources and have a positive output gap. When
this discussion into consideration, the purpose of firms increase prices to respond to the rising
this review study is to develop a better costs to maintain their profits, cost-push inflation
understanding of the inflation rate and how it occurs. Whereas, administered prices are
affects the economy sectors i.e. materials, associated with the governmental changes in
labours, and machinery. In addition, the impact prices of utilities and the taxes. There are several
of inflation rate on the construction industry is other factors influencing the inflation rate, such
also discussed in detail and a conceptual as total money supply, exchange rates, gross
framework is proposed. domestic product (GDP) and foreign exchange
reserves [24]. The increase in prices is due to
2. Causes of inflation inflationary pressures triggered by the pressure of
supply and demand sides of the economy [22].
Inflation is utterly uncherished, as many Factors influenc-
deplore, from consumers to government officials
due to the constant price rise. However, for many Table 1
people, the causes of inflation are led [20]. The Causes of inflation 1221
causes of inflation are: demand-pull inflation, S. Main Causes Sub Causes
cost-push inflation and administered prices [21- No
23]. The subdivisions of the main causes are 1 Demand Pull • Excess aggregate demand
outlined in Table 1. Inflation li. Money and credit boom
When aggregate demand expands at an 111.• Economy closes to full capacity
unsustainable rate, demand-pull inflation occurs, Positive output gap
 M.A. Musarat et al./Ain Shams Engineering Journal 12 (2021 ) 407—414 409
2 Cost Push Rising wage costs in labour marketFig. li. 3 indicates that the global economy
Inflation was faced with a downturn in 2019 relative to
Increasing raw material costs from domestic
and overseas suppliers the previous year but predicted to rise in 2020.
111. Rising import prices due to falling
For advanced economies, a linear decline is
exchange rate
3 Administered predicted. Whereas, emerging markets and
Changes in regulated prices e.g. water
Prices
bills developing economies experienced a small
downturn in 2019, but are expected to grow in
11. Changes in indirect taxes and subsidies
111. Changes in environmental taxes 2020.
ing inflationary pressures are addressed in Fig. 2,
which contributes to the key cause of inflation. 4. Inflation and gross domestic product of
ASEAN countries
3. Consequences of inflation on economy
Various countries are slowly implementing
Inflation in the economy refers to a inflation policies aimed at preserving price stability
quantitative measure of the rate at which the [29]. Indeed, Asian economies have undergone a
purchasing power of goods and services low and stable inflation policy [30].
decreases over time [25]. Within the economy, According to Statista [31], a firm inflation
inflation shows an upward trend in prices, rate in the ASEAN countries for the last 6
where it is essential to measure the increasing years was recorded, where the lowest was —
behaviour of prices over time [26]. Inflation 0.9% of Thailand in 2015 and highest 10.04%
has various effects on the economy that can be of Myanmar in 2015. Within the ASEAN
both positive and negative [27]. As the countries, Brunei Darussalam, Singapore and
country's domestic inflation rises, domestic Thailand have much more stable inflation rate,
investment in research and development (R hence having a better economic growth within
and D) along with technology growth their countries.
Maintaining a shallow and steady inflation rate
decreases. The country's economic growth in macroeconomic management is a challenge for
depends on domestic and international many countries where Malaysia's inflation is
technologies, and increasing global inflation eccentric [32]. The inflation rate in Malaysia
has an impact on the internal economy [281. showed diversified fluctuations from the year 1973
Fig. 3 shows the global growth projections to 2017, provided by the World Bank, with the
from the year 2018 to 2020. highest inflation reported as 17.3% in 1974 and the
lowest as 0.6% in 2009 [33].
"Gross domestic product (GDP) is a monetary
measure of the market value of all the final goods
and services produced in a specific time period,
often annually" [34]. GDP per capita usually
represents vari-
410 M.A. Musarat et al./Ain Shams Engineering Journal 12 (2021 ) 407—414

Increasing world
oil prices

Rapid expansion of money and

credit from banks

Fig. 2. Factors affecting inflationary pressures [22].

4.8
5

4.5

Global Economy Advanced Economies Emerging Markets & Developing

Economies

• 2018 02019 a 2020

Fig. 3. Global growth projections [741.

ations in inflation and living costs, where it is
more useful to compare differences in living
standards between nations on the basis of GDP
per capita at purchasing power parity (PPP) [35].
National economic health is calculated by GDP,
with consumption and investment as the main
factors [36].
In ASEAN countries, there is a non-linear
relationship between inflation and growth that
hinders economic growth in the region [27]. This
non-linear relationship between inflation and
economic growth is due to the complexity of the
relationship. This could mean that the
relationship between the two entities seems
unstable or virtually non-existent. However, non-
linear relationship between entities can be
connected in ways that are fairly predictable, but
more complex than in a linear relationship.
Based on the data given by Statista [31, 37],
inflation and GDP comparisons between ASEAN
countries were made from the year 2013 to 2018,
as discussed in Fig. 4.
 M.A. Musarat et al./Ain Shams Engineering Journal 12 (2021 ) 407—414 411
GDP growth occurred within 6 years for 5. Effects of inflation on construction industry
each country showing its economic stability.
The highest GDP is of Thailand and the lowest The construction industry and its operations
of Vietnam, while the highest inflation rate is are one of the main sources of economic growth
of Vietnam and the lowest of Thailand, and development [381. Construction and
indicating an inverse relationship between the engineering services play an important role in the
inflation rate and GDP. The country ranking economic upswing of the world, generating job
against GDP cannot be justified in this respect, opportunities for millions of workers. The
as the population varies between countries construction industry employed 7,505,000
which have a direct impact on GDP. workers in July 2019 and projected a rise of
Overall, the above ASEAN countries are 864,700 new jobs by 2026, with an approximate
showing a smooth rise in GDP, showing a non- growth rate of 12% [39]. It also raises the
linear inflation-to-GDP ratio, as Thanh [27] revenue due to foreign trade in construction
pointed out, except for Vietnam, which showed materials and engineering ser-
an abrupt drop in the inflation rate from 6.60% in
2013 to 0.52% in 2015.
412 M.A. Musarat et al./Ain Shams Engineering Journal 12 (2021 ) 407—414
$500

$450

$350

$300

$250

$200

$150

$100

-1%
$50
2013 2014 2015 2016 2017 2018 Vietnam GDP Malaysia GDP Phlippines GDP Singapore GDP Thailand GDP

— Vietnam Inflation — — — Malaysia Inflation — Phlippines Inflation — Singapore Inflation — Thailand Inflation

Fig. 4. Inflation and GDP comparison of ASEAN Countries.

vices [401. The importance of the construction materials, labour and machinery cost increases
industry is due not only to its immense size, but annually due to inflation. Inflation plays a vital
also to its contribution to other industries [41- role in the price increase of materials, labours,
471. Table 2 indicates the contribution of the and machinery, which results in deviating the
construction industry to GDP in different initial and the final cost of the project.
countries. Construction costs are volatile, and the prices of
It can be seen that a major contribution is materials and other costs are continuously
made by the construction industry, demonstrating fluctuating, creating volatility in economic
its role in the growth of the economy of the growth. Not only economic growth but also the
country. labour market and consumer price index are
S. No Country affected by inflation [48—50]. Labour and
material costs also influence inflation, but there
1 United Kingdom
is a huge change due to contractors and suppliers'
2 European Union
Indonesia margins. Construction industry inflation is
3
Singapore different among various sectors and varies from
4
5
Finland market to market. Even it differs from material to
6 material [51]. The construction industry is
7 important

Table 2
Construction Industry contribution to GDP.
for any nation to build its economy, as there are
Germany
huge investments involved. But inflation is
8 becoming a major problem, having a negative
Italy
9 Georgia impact on the construction industry. Inflation is
10 Poland causing an increase in the prices of materials,
11 Iceland machinery and other inputs to construction projects.
12 Austria Where no other option is left to project parties than
13 Malaysia
delaying the project in order to prevent cost overrun,
United States
which are primarily due to inflation [52]. Building
materials impact 35% to 60% of overall
construction cost [53—55]. The principle how
inflation affects building materials prices, labour
wages and machinery hire rates is the time lag
behaviour of these components [56—58]. A.
Budget is the main parameter for any Windapo and Cattell [591 presented a conceptual
construction project. In projects with a long model of the factors influencing the price of
duration, it is normal for the budget to be revised. building materials as shown in Fig. 5.
One of the reasons for this is that the building
 M.A. Musarat et al./Ain Shams Engineering Journal 12 (2021 ) 407—414 413

Supply Reinforcing SteelConstruction

Costs
Cement
Demand
Market
Cement Blocks
Conditions
Crushed Stone
Transport costs Stock Bricks
Energy costs Sand
SA PineKiln
Dried Construction
Industry
Raw Material Performance
Labour costs
Galvanized Roofg
Inflation
Aluminium Roofg
Crude Oil Prices
Exchange Rates
Ceiling Material
Import Duties
Electrical Material
Fig. 5. Conceptual model of the factors affecting building material prices [591.
It can be observed that there are many Cost overrun is a common problem for both
factors involved in deviating the material costs developed and developing countries in the
mainly; supply and demand, market construction industry. In construction projects,
conditions, transport and energy costs, raw cost deviation occurs which could either be
materials, labour costs, crude oil prices, positive or negative and if it is positive it
exchange rates, import duties and inflation that indicates the cost overrun [61—63].
influence construction costs as well as the There is a significant relationship between cost
output of the construction industry. overrun and inflation in both public and private
Inflation persists in the construction construction projects [64,65]. According to
industry for a longer time, although it was not Oghenekevwe et al. [66], the major cost overrun
important at the beginning of the era, it is now distress is the rise in construction materials costs
heavily involved due to technical due to inflation. Goyal [671 concluded in his
advancement, massive construc- study that the rise in materials prices is due to
tion projects, client's complexity and many other inflation, which contributes to cost overrun. He
variations to meet the requirements. When also reported that not only material prices but
inflation rate increases, an increase in the prices also labour wages are affected by inflation,
of the materials can also be observed. Clients not which has had an impact on the final project cost.
only account for the rise in construction costs but Inflation not only increases the prices of
also pay a surcharge on construction prices due materials, but also
to vagueness of inflation [60].
Table 3
Summary of the effects of inflation in various regions.

Author & Year Study Area Method Cost Overrun Remarks

Materials Labour Machinery/

Equipment
Niazi and Afghanistan Relative Importance Index Corruption, delay in payment by the owner, difficulties in
Painting (RID financing the contractor's project, security, change of order
[82] during construction and market inflation are the main causes
of construction cost overrun
Oghenekevwe et Nigeria Regression Analysis The major cost overrun distress is the rise in construction
al. [661 materials prices due to inflation
Goyal [671 India Comparison of budgeted and The increase in material prices is due to inflation, which leads
actual cost of a project to to cost overrun. Not only material prices, but also labour wages
calculate cost overrun are affected by inflation
Haslinda et al. Malaysia Frequency Index Material costs rose due to inflation, poor pre-construction
[83] budget and material cost planning and inaccurate quantity
take-off are key factors causing cost overrun
Tang [581 Malaysia Bounds Testing Approach There is a relationship between real wages, inflation and labour
productivity
 414 M.A. Musarat et al./Ain Shams Engineering Journal 12 (2021 ) 407—414
Leavitt et al. United Cost escalation of previous Inflation is one of the major cost overrun factors
States project
Enshassi et al. Palestine Relative Importance Index Major causes of overrun costs in the Gaza Strip include
[63] (RID fluctuation in materials prices, delay in delivery of materials
and equipment by the contractor and inflation
Olawale and UK Relative Importance Index Inflation of prices is one of the key factors causing cost overrun
Sun [85] (RID
Aziz [86] Egypt Relative Importance Index In addition to many other factors, inflation and fluctuation in
(RID the prices of raw materials are responsible for cost overrun
Amusan et al. [87] Nigeria Severity Index N/A Inflation is one of the critical factors causing cost overrun

Johnson and UAE Weighted score method N/A Lack of attention to inflation is causing cost overrun
Babu [501
Le-Hoai et al. Vietnam Spearman's rank correlation Top 3 causes of cost overrun are an increase in materials cost
due
[88] test to inflation, an increase in labour cost and quantity takeoffs
Kaliba et al. Zambia Average weighted perceived Cost escalation is due to various factors, inflation is one of them
[89] significance
Alinaitwe Uganda Relative Importance Index Inflation is causing an increase in the prices of materials and
et al. [521 (RID equipment, contributing to cost overrun

Fig. 6. Conceptual framework.

impacts labour wages [68]. Akanni et al. [69] the construction budget. The budgets are based
worked on the rising cost of building materials in on available cost data and, if the duration of the
the state of Lagos, Nigeria, where variables in the project is long, inflation should be considered
cost of construction materials were quantitatively while the budget is being formalized [711.
analyzed. The study showed an inflationary trend
in construction materials prices from the year
2003 to 2012, with an inflation rate of 5% to 6. Discussion
21%, respectively.
Tang [58] examined the effect of real labour wages There is a relationship between inflation and
and inflation on productivity in Malaysia. The study the performance of the construction industry
period lasted from the year 1970 to 2007, where it was which has an impact on economic growth. Based
reported that there is a relationship between real labour on the literature, a conceptual framework for a
wages, inflation and productivity in Malaysia.
Furthermore, the analysis revealed the negative impact better understanding of this scenario has been
of inflation and productivity and thus demonstrated the developed. The framework is discussed in Fig. 6.
value of real labour wages and inflation for Not only does the inflation rate influence the
productivity in Malaysia. The inflation effect on the construction industry, but sometimes the growth
Irish construction sector is triggering and is identified rate of the construction industry also affects the
as a "key risk" for 2019. Also, the upward march of economy of the countries and the inflation rate
labour costs is imminently stiffening for new labours, The inflation rate influences GDP, and
which is a major constraint as it causing a lack of sometimes the GDP affects the inflation rate of
growth in the sector [701. Several researchers have
illustrated the effects of inflation in various regions, countries [24]. The inflation rate rise lowers GDP
few of which are listed in Table 3. but raises construction costs [65,66,271. Many
The summarized Table 3 indicates that factors affect construction costs, but mainly
inflation is causing cost overrun in many building material prices, labour wages,
countries by deviating the prices of materials, machinery hire rates and consultation fees, which
labour wages and machinery hire rates and are directly affected by the inflation rate and
portray a substantial impact on the precision of result in project cost overrun. The cost overrun
 M.A. Musarat et al./Ain Shams Engineering Journal 12 (2021 ) 407—414 415
affects the construction industry and economic xi
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