Contract Indexation Guide for Businesses
Contract Indexation Guide
for Businesses
1
Reproduction of material
Material in this report may be reproduced and published, provided that it does not purport to be
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Citation
Statistics New Zealand (2009). Contract indexation guide for businesses.
Wellington: Statistics New Zealand
Published in November 2009 by
Statistics New Zealand
Tatauranga Aotearoa
Wellington, New Zealand
ISBN 978-0-478-35374-7 (online)
Contract Indexation Guide for Businesses
Preface
Parties that engage in commercial contracts use a range of price indexes produced by
Statistics New Zealand in their indexation clauses. Contract Indexation Guide for
Businesses provides general guidelines relating to the use of each index in commercial
contracts, including information on index quality, revisions, discontinuities, and rebasing.
In the process of contract indexation, it is important to understand the merits and
limitations of each index based on the specific nature, characteristics, and methodology
of the indexes.
The role of Statistics NZ in relation to indexation clauses is limited to explaining the
methodologies and limitations of specific series, and to providing the data requested by
users in a timely and efficient manner. Statistics NZ aims to provide general advice on
the application of indexes in particular situations, but does not provide advice on
contractors’ obligations in private commercial contracts or on disputes arising from
contract interpretation.
Some points to consider when using a price index for contract indexation are explained
in this guide under each index. This information is based on Statistics NZ's experience as
a provider of price index data. It is not an exhaustive list of all the possible risks or pitfalls
associated with indexation. For more comprehensive information, legal advice should be
obtained. The guide concludes with an example of cost indexation using a simple
representative formula. There are several methods of constructing an indexation clause
and Statistics NZ does not recommend any particular method. The example provided is
for illustrative purposes only.
All statistics and information produced by Statistics NZ carry the following disclaimer:
While care has been used in processing, analysing, and extracting information,
Statistics NZ gives no warranty that the information supplied is free from error.
Statistics NZ shall not be liable for any loss suffered through the use, directly or
indirectly, of any information, product, or service.
Geoff Bascand
Government Statistician
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Contract Indexation Guide for Businesses
Further information
Source
All data is compiled by Statistics New Zealand, except where otherwise stated. Both
administrative and survey data has been used in this report.
Liability
While all care and diligence has been used in processing, analysing and extracting data
and information in this report, Statistics NZ gives no warranty it is error free and will not
be liable for any loss or damage suffered as a result of the use, directly or indirectly, of
information in this report.
Statistics New Zealand Information Centre
For further information about this guide, and for help finding and using statistical
information available on our website, including Infoshare and Table Builder, contact the
Information Centre:
Email:
Phone toll-free:
Phone international:
Fax:
Post:
Website:
[email protected]
0508 525 525
+64 4 931 4600
+64 4 931 4610
P O Box 2922, Wellington 6140, New Zealand
www.stats.govt.nz
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Contract Indexation Guide for Businesses
Contents
Introduction ...................................................................................................................................... 1
Commentary..................................................................................................................................... 2
Price indexes ................................................................................................................................................. 2
Statistics New Zealand’s price indexes .................................................................................... 5
Overview ........................................................................................................................................................ 5
Producers price index................................................................................................................................ 7
Labour cost index ....................................................................................................................................... 9
Capital goods price index ..................................................................................................................... 11
Overseas trade index .............................................................................................................................. 12
Consumers price index .......................................................................................................................... 14
Energy price indexes............................................................................................................................... 16
Retail trade deflators ............................................................................................................................... 16
Things to consider ........................................................................................................................ 19
List of tables
1. Price Indexes Produced by Statistics New Zealand .......................................................................6
2. Timing of Index Publication..................................................................................................................20
3. Index Number and Indexation Amounts for Producers Price Index and Labour Cost
Index, December 2002–March 2005 ...........................................................................................24
List of figures
1. Index Structure .............................................................................................................................................4
2. Inflation Flows in the Economy .............................................................................................................5
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Contract Indexation Guide for Businesses
Introduction
Statistics New Zealand’s price indexes are commonly used by New Zealand businesses
in contract indexation clauses (also known as contract escalation clauses). Contract
Indexation Guide for Businesses provides information on the price indexes produced by
Statistics NZ and issues relating to their use in such clauses. This guide also outlines
some points to consider when preparing an indexation clause and includes an example
of the mechanics of a simple indexation formula.
The contract indexation guide was first published in December 1998 and then updated
in 2005 to incorporate subsequent changes in the price indexes, including calculation
methodologies, weightings, and coverage. This version was updated in 2009.
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Contract Indexation Guide for Businesses
Commentary
Price indexes
Interpretation
A price index measures price changes for a fixed set of goods and services. For any set
of goods and services, a representative subset or ‘basket’ is selected for pricing. This
subset is a sample of the whole population of prices and is intended to represent price
changes across the whole set of goods and services being studied.
A price index measures the change in prices between time periods, rather than actual
prices. It does not measure the cost of living or production, the value of production, or
any other circumstance where factors other than price, for example quantity, may vary.
A price index is conventionally expressed on a base of 1000 in a particular time period,
usually a month or quarter, which is referred to as the index reference period. Price
indexes are ‘unit-less’. This means that the significance of a series of index numbers lies
in their relative values. A single index number has no information value. For an index to
provide information on price change, at least two index numbers from the same series
are required to derive the percentage change in price. The index numbers must relate to
the same basket of goods and services and to the same index reference period to
produce a meaningful result.
The particular time period that the regimen weights relate to is called the weight
reference period. The weight reference period usually covers at least one year. Regimen
weights are expenditure or revenue shares, based on the relative importance of items in
the basket. Regimen weights are applied to the price movements of items in the basket,
resulting in weighted average price movements. The price reference period is the
quarter or month that prices for subsequent periods are compared with. The weight
reference period and the price reference period may not necessarily be the same as the
index reference period (when the index has a value of 1000).
Characteristics
A price index is a statistical measure that provides a summary of price changes of the
goods and services represented by the items in its basket. This basket is itself a statistical
estimate, representing at a particular time the experience of households or businesses.
A price index, with a particular basket of selected goods and services for a chosen
reference period, is just one way of measuring price change. The results have certain
properties, such as variability, sample and non-sample error, and defined scope or
boundaries, which can result in the calculated price change varying from the true or
ideal value sought by users. The inflation measures produced by Statistics NZ are
therefore estimates of the actual change in prices. Over time they will fluctuate above
and/or below the true inflationary path.
The degree of accuracy of a price index will vary depending on the particular
characteristics of the index chosen. The nature of the commodities measured is one
factor that will affect accuracy. Services are particularly difficult to quantify – both the
level and quality of output are often difficult to accurately identify and price.
Furthermore, the level of disaggregation may affect quality, with indexes at the finest
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Contract Indexation Guide for Businesses
(that is, lowest) level generally having more variability than indexes at a more
aggregated level where volatility from sampling is smoothed out.
Most indexes currently produced by Statistics NZ are Laspeyres base-weighted indexes.
This means, the regimen weights are fixed at the base period of the index and the
underlying quantities do not vary until the index is reweighted or redeveloped.
Exceptions include the overseas trade price index (which is a Fisher ideal index and is
based on an average of current and base period weights), and the implicit price
deflators for gross domestic product (GDP) (which are based on current weights).
Typically, Statistics NZ price indexes are constructed in a hierarchical manner. At the
lowest level, actual prices for specific products are used to calculate indexes. These
products have very precise specifications so that similar commodities are priced over
time. This ensures that pure price movements are not distorted by changes in the
characteristics of commodities being surveyed. In the situations where commodity
specifications change, appropriate quality adjustment methodologies are applied to
minimise the quality effect on the measurement of the price movement. These
commodity level index results then form the building blocks for higher level indexes. An
example of this structure, as used in the machinery and equipment outputs index in the
producers price index, is given in figure 1.
In general, the degree of accuracy of an index will vary depending upon the nature of
the commodity group or industry measured and the level within the hierarchy from
which it is drawn. In most instances, there is a trade-off between choosing an index
which relates specifically to the area of interest (has a similar scope) and the statistical
accuracy of the index in terms of its variability, sample and non-sample error of the
underlying data, and other statistical properties.
The choice of an index for price indexation purposes is ultimately a matter of judgement
on the part of the contracting parties. In any particular instance, the various strengths
and weaknesses of the possible measures must be assessed against the users’ own
objectives for the contract.
In a low-inflation environment it is feasible that a price index will both increase and
decrease over time. If an indexation clause is specified in such a way that only increases
are accounted for (that is, a ratchet clause), one party to the contract may incur costs in
excess of that implied by the actual inflationary trend.
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Contract Indexation Guide for Businesses
Figure 1
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Contract Indexation Guide for Businesses
Statistics New Zealand’s price indexes
Overview
Statistics NZ produces a range of price indexes that measure inflation as it affects various
parts of the New Zealand economy. Figure 2 shows the relationships between some of
these indexes. Under each of the major index headings Statistics NZ produces a further
range of both published and unpublished sub-indexes. The following discussion
provides an overview of these index groupings, together with a summary of the main
issues relating to their use in indexation clauses.
Statistics NZ staff are available to provide further information on index methodology, the
range of indexes available, practical considerations concerning specific indexes, data
delivery, and the production of customised indexes. For each major index group there is
a greater range of indexes calculated each quarter than are actually published. Many of
these indexes can be released to users on request, subject to confidentiality and quality
constraints. However, for the use of indexes in contract indexation clauses, both parties
may prefer to use an index which is published and easily accessible.
Figure 2
Indexes not shown in figure 2
•
Food price index (FPI) – sub-index of the consumers price index (CPI)
•
Farm expenses price index (FEPI) – index of labour costs and current costs related
to farms
•
Energy price index (EPI) – sub-index of the CPI and the producers price index (PPI)
•
Retail trade deflators (RTD) – price index of retail sales
•
Implicit price deflators (IPD) – price index of all production in the economy.
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Contract Indexation Guide for Businesses
See table 1 for an outline of all price indexes produced by Statistics NZ, including the
formulas used for each.
Table 1
Price Indexes Produced by Statistics New Zealand
Index
Abbrevi- Description
ation
Frequ- Series available
ency*
Classification
since **
Subject Formula
to
revision?
Producers price
PPI
index – inputs
Producers price
Q
March 1959
Industry
Yes
Laspeyres
Q
March 1959
Industry
Yes
Laspeyres
Q
June 1998
Commodity
Yes
Laspeyres
Q, A1
June 1971
Farm type,
Yes
Laspeyres
Yes
Laspeyres
Yes
Laspeyres
Yes
Laspeyres
No
Laspeyres
No
Laspeyres
production
PPI
index – outputs
Producers price
Current costs of
Prices received for
production
PPI
index –
Commodity prices
received by producers
commodities
Farm expenses
FEPI
price index
Capital goods
to farms
CGPI
price index
Labour cost index
Current, and labour costs
Capital costs to
input type
Q
December 1979
Asset type
Q
December 1977*** Industry,
businesses
LCI
Wage and salary costs
– salary and
occupation,
wage rates
sector, labour
cost type
Labour cost index
LCI
– all labour costs
Wage, salary and other
A2
December 1992
labour costs
Industry,
sector, labour
cost type
Consumers price
CPI
index
Prices paid by private
Q
June 1914
households for goods
Commodity,
region
and services
Food price index
FPI
Food prices paid by
M
January 1960
private households
Overseas trade
OTI
index
Overseas trade
OTI
Q
Various
Commodity
Yes
Fisher
Prices of exports leaving
Q
Various
Commodity
Yes
Fisher
Q
December 1994
Energy type
Yes
Laspeyres
Q
June 1990
Industry
Yes
Laspeyres
New Zealand
EPI
index
Retail trade
region
Zealand
index
Energy price
Prices of imports to New
Commodity,
Energy prices paid by
private households
RTD
Price movements of
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Contract Indexation Guide for Businesses
deflators
Implicit price
retail sales
IPD
deflators
All production in New
Q
June 1982
Zealand
National
Yes
Accounts
* Q = quarterly; M = monthly; A1 = March quarter of each year for input types not included in
the PPI. Quarterly for other input types; A2 = June quarter of each year (quarterly prior to the
June 1999 quarter).
** The start date of some series, although a number of series have undergone name and scope
changes.
*** Prevailing weekly wage rates index until the December 1992 quarter.
Producers price index
The producers price index (PPI) is made up of two types of indexes: the outputs index,
which measures changes in the prices received by producers; and the inputs index,
which measures changes in the cost of production (excluding labour and capital costs).
Outputs
Nature and purpose
The PPI outputs index measures changes in the level of prices received at the factory
door by producers, for the goods and services they produce. The definition of output is
consistent with gross output as defined by the System of National Accounts (SNA).
The index includes the following outputs: all goods and services produced, revenue
from renting and leasing, capital work undertaken by own employees, and margins on
goods purchased for re-sale. Excluded from the index are: interest and dividends;
royalties and patent fees; receipts from insurance claims; subsidies and grants; goods
and services tax (GST); and other indirect taxes.
Classifications used
The PPI outputs consist of 56 published industry indexes, currently based on the
Australian and New Zealand Standard Industrial Classification (ANZSIC) 1996. This
classification replaced the New Zealand Standard Industrial Classification (NZSIC) in the
March 1996 quarter. Further changes to the indexes were made in the June 1998
quarter to align it more closely with the ANZSIC classification. Output price indexes for
the public administration and defence; education; and health and community services
industries are not currently produced, mainly as a result of the non-market nature of
these services. Although some changes towards market orientation in these activities
have occurred, the difficulties in defining and pricing the outputs due to complex
funding and charging arrangements in these sectors have prevented the development of
output indexes at this stage.
A range of price indexes are also published for significant commodities. Examples
include sheep and lamb, logs for export, ready-mixed concrete, and road freight.
Data sources – prices
Price data mainly comes from the Commodity Price Survey, which is conducted on a
quarterly basis. Approximately 10,000 prices are collected each quarter from about
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Contract Indexation Guide for Businesses
2,500 respondents. Most prices are collected for the 15th day of the middle month of
the quarter, although some prices are collected monthly or annually depending on the
nature of the commodities.
Data sources – weights
The PPI is a quarterly Laspeyres annual base-weighted index. The PPI indexes were last
fully re-weighted during 1996–1998, and the industry output indexes have been
progressively re-weighted from 2006 to date. The weighting data mainly comes from
the Commodity Data Collection surveys (2004–2008) and the Annual Enterprise
Surveys (2003–2007). Other data sources include import and export statistics,
company reports, government departments, industry organisations, and discussions with
businesses.
Timing
The index is published quarterly, approximately seven weeks after the end of each
quarter.
Inputs
Nature and purpose
The PPI inputs index is intended to measure price changes relating to the current costs
of production (excluding labour and capital costs) within the economy. The definition of
current costs of production is consistent with intermediate consumption as defined in
the SNA.
The index includes the following items of current expenditure: materials, fuels, and
electricity; transport and communication; commission and contract services; renting and
leasing of land, buildings, vehicles, and plant; business services; and net insurance. The
index excludes: wages and salaries; capital costs; indirect taxes (including GST and local
government rates); interest, royalties, and patent fees; and bad debts and donations.
Input costs to farms are published separately in more detail in the farm expenses price
index (FEPI). This measures price changes of fixed inputs of goods and services to the
farming industry, including current costs of production and wage and salary costs. The
FEPI indexes are published by farm type and commodity.
Classifications used, data sources for prices and weights, and timing
The classifications used, data sources for prices and weights, and timing for the PPI
inputs index are similar to those for the PPI outputs index except that the inputs index is
made up of 47 published industry indexes, defined by ANZSIC 1996. The PPI inputs
index is also subject to the revisions and changes in industry classification and index
reference period as discussed in the PPI outputs section.
Outputs and inputs
Considerations for indexation clauses
The PPI is produced mainly for use in the calculation of the country’s national accounts,
and concepts drawn from the SNA (such as intermediate consumption) may not
necessarily match the exact requirements for an indexation clause. For example, indirect
taxes such as road user charges are excluded. This may limit the use of the road
transport index in measuring the costs of road transport. Furthermore, the indexes
exclude labour and capital expenditure. The labour cost index and capital goods price
index may be used if these components are required. In general, the PPI is used for
economic analysis and contract indexation.
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Contract Indexation Guide for Businesses
The PPI is subject to revision, but is revised only for significant errors or to incorporate
significant methodology or quality improvements. As a general guide, a significant error
is usually defined to be at least plus or minus three index points at the published level
with revisions of lower level indexes usually but not necessarily leading to revisions at
higher levels. Any revision is indicated by an ‘R’ beside the revised number in published
tables. The need to minimise revisions for use in indexation clauses is balanced against
the requirements for other key uses, such as economic analysis and national accounts
deflation, where accurate up-to-date information is required.
Periodically, the PPI is also subject to changes in the industry classification. In general,
these occur infrequently and users are notified well in advance before any changes
occur. A change in the classification is likely to mean that an index series is discontinued
or is produced in parallel to the new series. In the June 1998 quarter, the ANZSIC
industry groupings were updated and the old series were discontinued. The index
reference period of the PPI was also changed at this time. All indexes are subject to reexpression, although changes to the index reference period occur infrequently. Details
on dealing with such changes are covered in the ‘Things to consider’ section.
An updated version of ANZSIC, published in 2006, will be implemented in the PPI in
2010 or 2011.
The FEPI, which measures price changes specific to inputs into the farming industry,
does not fully measure changes in the production costs of farming. This is because
production costs are not solely dependent on price movements, but are also dependent
on factors that affect productivity, such as technological advances, management
efficiency, and climate fluctuations. Capital expenditure and depreciation are also not
covered in the FEPI. For these, refer to the capital goods price index.
Labour cost index
Nature and purpose
The labour cost index (LCI) measures changes in labour costs. These costs consist of
base salary and ordinary-time wage rates, overtime wage rates, and non-wage labourrelated costs. The index essentially covers all employees aged 15 years and over, in all
occupations, and in all industries except domestic services.
Statistics NZ publishes the following types of labour cost indexes:
•
labour cost index (salary and wage rates)
•
labour cost index (non-wage labour costs)
•
labour cost index (all labour costs).
The salary and wage rates component of the LCI measures movements in base salary
rates, ordinary time wage rates, and overtime wage rates. The non-wage component
measures changes in the costs of annual leave and statutory holidays, superannuation,
Accident Compensation Corporation (ACC) employer premiums, medical insurance,
motor vehicles available for private use, and low-interest loans. The all labour costs
component measures changes in both pay rates and non-wage labour costs.
The salary and wage rates index is released quarterly; the non-wage labour costs and all
labour costs indexes are published only for the June quarter of each year. Up until the
June 1999 quarter, the all labour costs indexes were released quarterly.
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Contract Indexation Guide for Businesses
Classifications used
The LCI is made up of about 280 published indexes for quarterly salary and wage rates
and about 90 annually published indexes for all labour costs as defined by the following
classifications (including combinations):
•
by sector of ownership (based on the New Zealand Standard Institutional Sector
Classification – NZISC96)
•
by industry (Australian and New Zealand Standard Industrial Classification –
ANZSIC96)
•
by occupation (New Zealand Standard Classification of Occupations 1999 –
NZSCO99)
•
by labour cost type.
Data sources – wage and non-wage information
Wage information for a fixed set of job descriptions is obtained by a quarterly postal
survey of employers (Quarterly Labour Cost Survey for Wage and Salary Rates). As at the
September 2009 quarter, about 2,200 employers provided information on pay rates for
this survey. There are some 6,300 job descriptions for which salary and ordinary-time
wage rates are collected for the pay period (the pay period is the period that includes
th
the 15 day of the middle month of the surveyed quarter). There are also nearly 850
overtime descriptions, designed to track changes in overtime wage rates, attached to
ordinary time wage descriptions in the survey.
The non-wage information for the all labour costs index is collected annually by a set of
postal surveys of employers for the June quarter. Information on superannuation costs,
annual leave entitlements, and ACC employer premiums is collected in mid-May of each
year. Information on medical insurance costs, motor vehicles available for private use,
and low-interest loans is collected in July for the June quarter of each year.
Data sources – weights
Each job description used in calculating the salary and wage rates, and non-wage
indexes is assigned a weight that reflects the relative importance of the job description
within its sector of ownership, industry, and occupation group. For both indexes, weights
were calculated using 2006 Census of Population and Dwellings information on the
relative importance of occupations within each sector by industry group and Business
Frame information on the relative importance of industry groups within each sector. In
addition, the salary and wage rates index also used pay rates surveyed in the June 2008
quarter (see ‘Reweighting the labour cost index (salary and wage rates)’ in the January
2009 issue of Price Index News for further details). The non-wage index also used nonwage information surveyed in the June 2008 quarter.
Timing
The LCI (salary and wage rates) is published each quarter approximately five weeks after
the end of the quarter; the LCI (all labour costs) is published annually for the June
quarter, approximately 16 weeks after the end of the quarter.
Considerations for indexation clauses
Contract parties need to carefully consider which index to use, particularly the choice
between the index measuring salary and ordinary-time wage rates, or the index
measuring all salary and wage rates (including overtime as well as ordinary-time wage
rates). The latter index provides an overall measure of changes in pay rates and may be
considered the most appropriate one to use, even if there is no provision in the contract
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Contract Indexation Guide for Businesses
for working overtime. The all salary and wage rates index may be considered more
appropriate because it reflects the overall impact of trade-offs in ordinary-time and
overtime rates. Whereas, the salary and ordinary-time wage rates index reflects the
increase in ordinary-time rates, but not a related fall in overtime rates. Overtime hours
are held constant and the index is not affected by the varying number of overtime hours
worked from quarter to quarter. Whichever series is chosen, the index selected needs to
be carefully specified given the number of indexes relating to any particular area.
Another option is to use the LCI (all labour costs). However, it is only published annually
for the June quarter.
The LCI is subject to revision, and any revisions are indicated by an ‘R’ beside the
revised number in published tables. The need to minimise revisions for use in
indexation clauses is balanced against the requirements for other key uses, such as
economic analysis and in the country’s national accounts.
The LCI is also subject to changes in industry and occupation classifications, and index
reference period. In practice, this occurs at approximately five-yearly intervals.
The LCI relates to labour costs only and may need to be used in conjunction with an
index measuring current costs of production, such as the PPI inputs index, and an index
measuring capital expenditure, such as the capital goods price index.
Capital goods price index
Nature and purpose
The capital goods price index (CGPI) measures changes in the price levels of physical
capital assets purchased by producers of goods and services in the economy. Physical
capital assets are generally defined as items that are consumed over a period of greater
than a year.
Excluded from the index are non-recurring large-value items manufactured to customer
specifications (such as ships and aircraft) and second-hand equipment (such as cars).
The CGPI is primarily intended for use as a deflator for gross fixed capital formation in
the calculation of constant price GDP. However, the index can also be used for
economic analysis and contract indexation.
Classifications used
The CGPI is made up of 60 published indexes, organised by asset type and based on
the gross capital formation no.2 (fixed capital goods) classification.
Data sources – prices
The index is calculated quarterly from selected price quotes collected by the Commodity
Price Survey. Approximately 10,000 individual commodity items are surveyed from
about 2,500 respondents to provide prices for use in the CGPI and other business price
indexes. When calculating the CGPI, prices collected on the 15th day of the middle
month of the quarter are generally used to represent the entire quarter. Prices collected
for imported goods are often denominated in foreign currencies. These are then
converted to New Zealand dollars using the exchange rate at the time of price collection.
Data sources – weights
The weights of the commodities are determined by their relative importance within each
of the asset type indexes. Weighting information has been derived from statistics on
external trade, manufacturing and building, and vehicle registrations, as well as
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Contract Indexation Guide for Businesses
discussions with manufacturers, importers, wholesalers, and retailers. Data collected over
several years is used because expenditure on capital goods can be irregular. GST is
excluded from prices used in this index because it is recoverable for GST-registered
businesses.
Timing
The CGPI is published quarterly, approximately seven weeks after the end of the quarter.
Considerations for indexation clauses
The CGPI is produced mainly for use in the calculation of the country’s national
accounts, and concepts drawn from the System of National Accounts (such as ‘physical
capital assets purchased by producers’) may not necessarily match the exact
requirements for an indexation clause.
The CGPI is subject to revision but is revised only for significant errors. A significant error
is usually defined to be at least plus or minus three index points at the published level,
with revisions of asset type indexes usually but not necessarily leading to revisions at
higher levels. Any revision is indicated by an ‘R’ beside the revised number in published
tables. The need to minimise revisions for use in indexation clauses is balanced against
the need for other uses, such as economic analysis and national accounts deflation. In
practice, revisions are infrequent.
The CGPI is subject to periodic changes in the price reference period and asset-type
classification. When the CGPI was last redeveloped, the index was re-based on the
September 1999 quarter (=1000).
Separating price change from other changes, such as quality change, is particularly
difficult for some capital goods. Therefore, some indexes may not accurately reflect price
movements, although Statistics NZ takes steps to minimise this bias. Likewise, the
limited number of producers of certain capital goods may mean that indexes are
discontinued to protect respondent confidentiality.
Overseas trade index
Nature and purpose
The overseas trade index (OTI) includes both an export price index and an import price
index of both merchandise and services of overseas trade. Also included in the OTI are
the terms of trade indexes and volume indexes for merchandise imports and exports.
The merchandise trade price indexes are intended to measure the change in price levels
of imports and exports of merchandise trade to and from New Zealand. The
merchandise trade indexes are calculated both quarterly and annually. The services
indexes measure the changes in price levels only on a quarterly basis.
All merchandise trade price index series are expressed on a base of the June 2002
quarter (=1000).
Classifications used
The OTI uses the New Zealand Harmonised System Classification (NZHSC) and New
Zealand Standard Classification by Broad Economic Categories (NZBEC).
Data sources – prices
The index is calculated mainly using unit values. Unit values are ‘prices’ that are derived
from Statistics NZ overseas merchandise trade statistics, which are in turn processed
from export and import entry documents lodged with the New Zealand Customs
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Contract Indexation Guide for Businesses
Service. Unit values are calculated by dividing the total value of an item exported or
imported during the quarter by the total quantity exported or imported during the
quarter. The unit value data have been selectively supplemented with prices collected
directly from importers and exporters via the Commodity Price Survey and by
international price indexes. International price indexes are used as a proxy for change in
prices faced by New Zealand importers for goods that are irregularly imported or
imported to one-off specifications, and for technically complex goods subject to rapid
quality change.
The imports are valued on a New Zealand Dollar value for duty basis. The export
indexes use New Zealand free on board values.
Data sources – weights
The OTI is calculated using a Fisher ideal index formulation. Accordingly, both current
weights and base weights are used in the calculation. The expenditure weights are
assigned at the 10-digit harmonised system (HS) item code by country level. Current
weighting data are obtained from the values of the exports and imports for the year to
the current quarter. Base weights are obtained using the previous June year’s values.
Timing
Provisional results of the 57 published OTI price indexes are released about 10 weeks
after the end of each quarter; the final results are released within 23 weeks.
Considerations for indexation clauses
Data used in calculating the OTI is made up of unit values, which have some limitations.
Where there is a mix of goods exported or imported under an HS item code, and the
mix differs from quarter to quarter, this change in mix can have an effect on the derived
unit value. In general, HS item descriptions are reasonably precise, and goods classified
under particular codes are sufficiently homogeneous that any change in mix is unlikely
to have a significant effect on item unit values. In other areas such as pharmaceutical
products, HS items do not have statistical units of quantity. Unit values cannot be
calculated for such items so they are imputed. The unit values do not provide good
indicators of price change for heterogeneous goods, such as elaborately transformed
goods, technically complex goods, or goods subjected to rapid quality change.
Unit values are selectively supplemented by international price indexes and with explicit
prices collected directly from exporters and importers. At present about 80 percent of
the total value of exports and about 65 percent of the total value of imports are used
explicitly in the calculation of the total exports and total imports indexes, respectively.
This means that about 20 percent of export prices and 35 percent of import prices are
imputed each quarter.
Export values given in foreign currencies are converted by Statistics NZ into New Zealand
dollars using weekly exchange rates when the statistics are compiled. For exports, a rise
in the New Zealand dollar has a downward influence on prices.
Import values are converted from foreign currencies when import documents are
processed by the New Zealand Customs Service. The exchange rates used are set by
Customs each fortnight. These rates are prepared 11 days prior to the start of the
fortnight, so they have a lag of between 11 and 25 days compared with the daily rates
published by the Reserve Bank. For imports, a rise in the New Zealand dollar has a
downward influence on prices.
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Contract Indexation Guide for Businesses
Consumers price index
Nature and purpose
The consumers price index (CPI) measures the rate of price change of goods and
services purchased by private households. The index measures the changing cost of
purchasing a fixed basket of goods and services representing the average expenditure
pattern of households during the weight reference period.
The CPI all groups index is prepared quarterly. Food is the only commodity group of the
CPI which is prepared each month, as the food price index (FPI).
The CPI is used as a measure of inflation; to help with the setting of monetary policy; as
an indicator of the effect of price change on the purchasing power of households’
incomes; as a means to adjust benefits, allowances, incomes, and monetary values; and
as a price deflator.
Classifications used
The CPI is divided into 11 commodity groups. The groupings are mutually exclusive and
comprehensive in their coverage.
Data sources – prices
About 120,000 prices of about 690 representative goods and services are collected
each quarter. Prices are surveyed by personal visit, by mail, or directly from collection
agencies (administrative or electronic collection) depending on the item.
When prices are controlled by a national authority and the same price applies to all
regions (eg motor vehicle relicensing fees), or when the expenditure on an item is not
linked to the area of residence (eg hotel and motel accommodation), or when the
sample size means that regional data would be unreliable, national average prices are
used. This means that the same price is used for each region in the CPI.
Many items are priced at the mid-point of each quarter. Items showing volatile price
behaviour or that have large weights are often collected monthly (eg food and
electricity). Petrol, diesel, and fresh fruit and vegetable prices, which are also volatile, are
collected weekly.
Items where prices are set once a year, like tertiary education fees, are surveyed
annually.
Data sources – weights
The CPI is reweighted, and the basket of goods and services reselected, approximately
every three years. The process of reviewing the index addresses changes in spending
patterns and the introduction of new goods and services to ensure the CPI continues to
provide an accurate measure of price changes experienced by private households. The
current CPI was reweighted as at the June 2008 quarter, but has an index reference
period of the June 2006 quarter (=1000).
Expenditure weights are derived mainly from the Household Economic Survey (HES)
and show the proportion of average household expenditure on categories in the
regimen. The FPI was last reweighted as at the June 2006 month.
For a number of reasons, not all HES-based estimates are suitable for calculating
weights in the CPI. Data showing unusual expenditure trends are investigated using
information from manufacturers, retailers, and other surveys and sources, and adjusted if
necessary. Expenditure in some areas of the HES, such as tobacco and alcohol, is known
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Contract Indexation Guide for Businesses
to be under reported. For these areas, the CPI weights are based on a variety of
production and trade statistics.
Population figures are used to allocate national expenditure weights across the regions.
These are based on the most recent Census of Population and Dwellings, which is
currently the 2006 Census.
For further information on the most recent reweight, please refer to the information
paper Consumers Price Index, 2008 Review available on the Statistics NZ website.
Timing
The CPI is published quarterly, approximately 12 working days after the end of each
quarter.
Considerations for indexation clauses
The CPI is a high-profile measure and is often used in contract situations other than for
household spending. In business, capital expenditure, or labour-cost situations, it may be
more appropriate to consider one of the other price indexes (PPI, CGPI, LCI) produced
by Statistics NZ.
The CPI is frequently referred to as a cost-of-living index. This is not strictly true because
a cost-of-living index measures the price movements of a constantly changing basket of
goods and services, which provides a constant level of satisfaction. In contrast, the CPI
measures the price movements of a fixed basket of goods, which may not necessarily
provide that fixed level of satisfaction.
The published CPI is generally not subject to revisions. If a minor error is detected, it is
corrected in the following quarter.
The design, methodology, and calculation of the CPI are subject to independent review
and user consultation. A Revision Advisory Committee (RAC) is established at
approximately six-yearly intervals to provide the Government Statistician with advice on
the upcoming review of the CPI. The most recent RAC was convened in June 2004.
15
Contract Indexation Guide for Businesses
Energy price indexes
Nature and purpose
The Energy price indexes (EPIs) measure changes in prices of different types of energy
consumed by businesses and households. They are intended for analysis of energy
prices and are available for use in indexation.
These indexes are compiled by Statistics NZ but are published on the Ministry of
Economic Development website.
Classifications used
Eleven indexes are published by consumer (business or household) and energy type.
Data sources – prices
The energy prices paid by households, which are collected for the CPI, are used for
household energy price indexes. Monthly prices are collected for electricity and gas.
Firewood prices are collected in the middle of the quarter. Petrol and diesel prices are
collected weekly.
The commercial price indexes are compiled from the Commodity Price Survey used for
the PPI. Prices are collected mainly by postal survey with respondents supplying the
price at the mid-point of the quarter. Electricity, liquefied petroleum gas (LPG), and
natural gas prices are collected from local supply companies and include delivery costs.
Bulk diesel and petrol prices, including delivery, are collected from oil companies at
several locations around New Zealand. Coal prices are collected from mining companies
and exclude delivery costs.
Data sources – weights
The weights are derived by using the same weight information used in either the PPI or
the CPI, depending on the consumer type.
Timing
The EPI are published quarterly, approximately eight weeks after the end of the quarter.
Considerations for indexation clauses
The indexes are subject to revisions and changes in energy type and index reference
period.
Retail trade deflators
Nature and purpose
Retail Trade deflators measure changes in the prices of goods and services sold by
businesses in the 24 industries published in the Retail Trade Survey (RTS). The deflators
are used to remove the effect of price change from quarterly actual retail sales values,
seasonally-adjusted retail sales values, and trend retail sales values. The deflators are
fixed base-weighted Laspeyres price indexes calculated using the price-relative form of
the Laspeyres formula:
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Contract Indexation Guide for Businesses
where:
Pjt = RTS deflator of RTS industry j, for period t
Wi0 = base weight of i th CPI index or Commodity Price Survey indicator of n in
RTS deflator j
Iit = index number for period t of i th CPI index or Commodity Price Survey
indicator of n in RTS deflator j
Ii0 = index number for base period of i th CPI index or Commodity Price Survey
indicator of n in RTS deflator j
The deflator for each RTS industry consists of a basket of indexes drawn mainly from the
CPI. In a few RTS industries, prices collected via the Commodity Price Survey are also
used. The CPI indexes and Commodity Price Survey indicators in each deflator’s basket
represent the goods and services sold by the industry and are weighted to reflect the
mix of goods and services sold by the industry.
Classifications used
The indexes are published for 24 retail industry groups based on the Australian and
New Zealand Standard Industrial Classification (ANZSIC).
Data sources – prices
Prices are generally collected by the CPI price surveys, although a few prices are
collected using the Commodity Price Survey.
Data sources – weights
The Household Economic Survey (HES) is the main source of information used to
weight the deflators. To derive weights, expenditure information within store types from
the 2001/02 HES was supplemented with information from industry and other sources.
Weights at lower levels were updated in 2006 and 2008 to reflect the CPI reweights
implemented in 2006 and 2008.
Timing
The retail trade deflators are published quarterly in tables 16 and 17 of the RTS Hot Off
the Press, approximately six weeks after each calendar quarter.
Considerations for indexation clauses
The indexes are intended primarily to deflate retail sales. The indexes are subject to
revision and changes in classification and price reference period. The deflators are
currently expressed on a base of the September 1995 quarter (=1000).
Implicit price deflator
The GDP implicit price deflator (IPD) is a measure of the movement in prices for all
goods and services produced in New Zealand. The IPD is a Paasche index. It can only be
used to measure price movements between the base period and the current period.
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Contract Indexation Guide for Businesses
The IPD categories correspond to national accounts aggregates. The intended use of the
IPD is in conjunction with other national accounts measures, such as GDP, for macroeconomic analysis.
Data sources – prices and weights
The IPD is not calculated using observed prices. Rather, it is derived using values
calculated from GDP. Hence, it is an ‘implicit’ as opposed to a direct measure of price
movements, unlike most other price indexes.
Considerations for indexation clauses
The categories that the IPD use correspond to national accounts aggregates. These may
not necessarily correspond to categories that would be useful for contract indexation
clauses. The IPD can only be used to measure price movements between the base
period and the current period. Movements in the index between any other two periods
will include relative changes in the quantity weights as well as price movements. For this
reason the IPD is not recommended for contract indexation.
The IPD is subject to revision. This is due to the nature of the data and the need to
maintain consistency with published macro-economic statistics. The IPD deflator is
published almost three months after the end of the reference quarter. Other price
indexes are published earlier.
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Contract Indexation Guide for Businesses
Things to consider
1. Seek legal advice
It is suggested that legal advice be obtained when preparing a contract indexation
clause, as its use may have significant impact on the outcome of your business.
2. Index methodology
Most indexes are not designed specifically for use in contract indexation. Rather, they are
designed either as general measures of inflation or for use in national accounts. This
does not discount their use in contract indexation, rather it provides a limitation that
may, or may not, result in the index being inappropriate. Details relating to each index
are discussed in this guide.
3. Choice of index
Statistics NZ produces a range of indexes that measure different aspects of inflation.
Contracting parties have a choice of indexes and should not necessarily use a published
measure. Generally, contracting parties wanting to index household-related values
should consider using the CPI, while those wanting to index business-related values
should consider using the PPI (inputs), LCI, and possibly the CGPI in combination.
Users should be aware that the choice of an index can imply particular outcomes in
relation to a contract. For example, using the CPI to index wage movements means the
wages would be adjusted to compensate for price changes faced by consumers rather
than reflecting changing business conditions.
4. Level of index
Most indexes are produced according to a hierarchical structure (see figure 1), with
indexes at several levels within the hierarchy published. Contracting parties need to
decide what level of index to use.
Lower-level indexes are more specific and can more closely match the activity being
indexed. However, compared with indexes at a higher level, they may have more
random variability since they contain fewer price quotes. Generally, they also have less
accurate weighting information. Furthermore, lower-level indexes tend to be more
volatile. This is due to the smaller number of price quotes used and the greater
influence that any one price quote can have on the index result. Likewise, the specific
nature of lower-level indexes means that there is likely to be a greater correlation
between movements in price quotes.
Indexes at a high level tend to show less volatility due to both a greater number of, and
reduced correlation between, price quotes. However, indexes at a higher level may
include activities unrelated to the actual activity covered in the contract.
5. Back series
The back series available for some indexes may limit their use in a contract if the
contract is retrospective.
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Contract Indexation Guide for Businesses
6. Timing
The timing of publication of an index may also be a consideration. Table 2 gives the
timing of publication for the main price indexes.
Table 2
Timing of Index Publication
Index
Time after reference period
Producers price index
7 weeks after quarter
Capital goods price index
7 weeks after quarter
Labour cost index (salary and wage rates)
5 weeks after quarter
Labour cost index (all labour costs
16 weeks after June quarter
Overseas trade index (provisional)
10 weeks after quarter
Overseas trade index (final)
23 weeks after quarter
Consumers price index
12 working days after quarter
Food price index
9 working days after month, except for third month of
each quarter when published with the CPI
Retail trade deflators
6 weeks after quarter
For actual dates, see the release calendar on the Statistics NZ website.
7. Use actual index numbers
Most price indexes are published with supporting information such as percentage
changes, average prices, or points effect. For contract indexation, the use of this
supporting information should be avoided. In order to minimise the potential for error, it
is preferable to use the latest actual index numbers published.
8. Avoid ambiguity
There are several possible sources of ambiguity associated with indexation clauses. The
index used in the contract needs to be specified carefully to avoid the potential for
dispute. For example, poorly specified index names can be one source of confusion.
This is illustrated by the range of LCI indexes available for an area such as construction:
•
construction, private sector, salary and ordinary-time wage rates
•
construction, private sector, all salary and wage rates
•
construction, private sector, all labour costs
•
construction, all sectors combined, salary and ordinary-time wage rates
•
construction, all sectors combined, all salary and wage rates
•
construction, all sectors combined, all labour costs.
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Contract Indexation Guide for Businesses
Another major source of contention arises from ambiguous references to dates,
particularly in relation to the base period, or locking a clause into a specific base period
and thus not allowing for re-expression on a new index reference period.
9. Source of data
The source of the index numbers should be agreed, particularly if the index number
used is ‘first published’. The index numbers are published initially in the Hot Off the
Press (and on Infoshare) and subsequently in publications such as Key Statistics, the
Yearbook, and other topic-based publications. The Hot Off the Press is the first release
of the data and contains commentary, explanatory notes, and other information that
may be relevant to users. Key Statistics is a quarterly publication, which includes on
Statistics NZ’s major outputs.
10. Revisions
Some indexes are subject to revision. This means that an index number previously
published may change. Contracting parties need to consider what to do in the event that
index numbers they use are revised. A common way to deal with this is to specify that
first published index numbers are used and not to consider revisions. However, this
exposes both parties to the risk of being disadvantaged if revisions are introduced.
11. Change of index reference period
The index reference period of a price index is updated from time to time. Generally,
when the index reference period changes, the ‘levels’ of the index change but the
‘movements’ of the previously published series are not affected. This change in the level
needs to be taken into account. This can be done by using a formula that uses ratios,
illustrated in example 1 at the end of this section. If the index reference period was to
change then the index number used as the base in the formula would also change. The
index number for the current quarter, on the new expression base, can then be used.
Whenever an index is re-expressed on a new index reference period it is recommended
that users adopt the new official index series, where available, rather than calculating
unofficial rebase factors to adjust ongoing published figures or previously published
figures.
12. Discontinuities
The possibility of discontinued series also needs to be taken into account. In this event,
the change will be advised well in advance by Statistics NZ, with details usually
published in the Hot Off the Press for the index. Furthermore, Statistics NZ is happy to
discuss the discontinuity with users. Discontinuities may occur for one or more of
several reasons:
•
change in classification, resulting in new series being published
•
disaggregation of existing index
•
aggregation of existing indexes
•
index discontinued altogether
•
change of methodology.
The most frequent reason for a discontinuity is a change in classification. In this case,
there is usually a similar index matching the discontinued index, although its scope may
differ. When a change in aggregation occurs, the activity that the contracting parties want
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Contract Indexation Guide for Businesses
to capture might dictate which index to use as a replacement. In the case of changed
methodology, it is recommended that users consider the change and the
appropriateness of any replacement indexes to their particular situation.
In any case, the discontinued index used in an indexation clause will need to be linked
to a new index. To provide some guidance, the following is one method of linking the
series.
Step 1: Identify the existing series and the new replacement series
For example, if you had been using the PPI sub-group 15 ‘construction’ index, this index
would have been replaced in the June 1998 quarter by the industry E01 ‘construction’
index. In this case there is a one-to-one match. However, in other cases there are
several possible choices (one-to-many). For example, ‘machinery and metal products’
was split into three industry indexes at the same time. Any one of these industries could
have been chosen as replacements.
Step 2: Decide link period
In example 1 there is sufficient overlap in the two series to allow linking. A user would
then have to decide when to link. Up until the December 1997 quarter the movements
were based on the old series. Since the March 1998 quarter, including the movement
from the December 1997 quarter, the PPI has been based on the new series.
Step 3: Decide how to link
There are several options available for linking. Linking back is used in the following
example. In this case a link factor is calculated, which is used to convert the old series to
the new index reference period, thereby making it comparable with the new series while
preserving the movements of the old series.
Example 1
Suppose the rope manufacture index is to be linked to the string manufacture index.
The rope manufacture index is discontinued after the March 1998 quarter, while the
string manufacture index begins with the December 1997 quarter.
First, the link period is decided. In this example the December 1997 quarter is chosen.
Next, the index numbers in the old series prior to the link quarter (that is June 1997 and
September 1997) are multiplied by a link factor, which is 1000/1838. Decimal places
should be retained after the link factor is applied to preserve published movements on
the original index reference period. Following the link period, the index numbers from
the new series are used.
If a linked series on the previous index reference period is required, then the link factor
is inverted (1838/1000) and applied to the new series following the link period. This
calculation will have to be done for each additional index number that is added to the
series.
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Contract Indexation Guide for Businesses
13. Prices may move down as well as up
In a low-inflation environment it is feasible that a price index will both increase and
decrease over time. If an indexation clause is specified in such a way that only increases
are accounted for (a ratchet clause), one party to the contract may incur costs in excess
of that implied by the actual inflationary trend.
14. Forecasting future movements
Some contracting parties indicate that they require an index that will show either the
maximum increase or maximum decrease related to a particular contract. Statistics NZ
cannot provide such advice and does not predict future movements of indexes.
Organisations such as the Reserve Bank, the Treasury, trading banks, and economic
consultancies do forecast or project future movements of the main price indexes.
15. Statistics NZ advice
Statistics NZ staff are available to advise users on index methodology, the range of
indexes available in relation to a particular area, practical considerations concerning
specific indexes, data delivery, and the production of customised indexes.
Example 2 shows the mechanics of a simple indexation clause (cost fluctuation
adjustment clause). There are several possible approaches to constructing such clauses
and Statistics NZ does not recommend any particular approach. In this example a
contract to maintain aircraft has been entered into.
Example 2
1.1 A quarterly fee of $80,000 shall be paid by the principal to the contractor,
commencing with the December 2002 quarter (referred to as the contract base date).
This fee shall be indexed on a quarterly basis using the PPI and LCI as specified in
clause 1.2.
1.2 The quarterly indexation amount shall be as calculated by the following formula:
C = V * ((X * L / L’) + (Y * M / M')) – V
where:
C = indexation total
V = $80,000 (the starting value of the contract)
X = 0.6 (the weight attributed to the expenditure on labour costs)
L = LCI for the current quarter ‘Private sector, all salary and wage rates, machinery
and equipment manufacturing’ industry group
L' = LCI for the base quarter specified in the contract ‘Private sector, all salary and
wage rates, machinery and equipment manufacturing’ industry group
Y = 0.4 (the weight attributed to the expenditure on current costs)
M = producers price inputs index for the current quarter 'machinery and
equipment manufacturing’ industry group
M' = producers price inputs index for the base quarter specified in the contract
‘machinery and equipment manufacturing’ industry group
Table 3 gives the index numbers and the indexation amounts for the December 2002
to March 2005 quarters.
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Contract Indexation Guide for Businesses
Table 3
Index Number and Indexation Amounts for Producers Price Index and
Labour Cost Index
December 2002–March 2005
Quarter
PPI
LCI
Indexation ($)
Total amount ($)
Dec-02
1150
1041
0.00
80,000.00
Mar-03
1146
1044
27.02
80,027.02
Jun-03
1133
1047
-196.39
79,803.61
Sep-03
1131
1052
-21.49
79,978.51
Dec-03
1120
1059
-4.81
79,995.19
Mar-04
1127
1063
374.41
80,374.41
Jun-04
1173
1069
1,931.07
81,931.07
Sep-04
1190
1075
2,680.77
82,680.77
Dec-04
1204
1086
3,577.54
83,577.54
Mar-05
1206
1092
3,909.85
83,909.85
Using the formula, the indexation amount for the December 2004 quarter is:
C = $80,000 * ((0.6 * 1086 / 1041) + (0.4 * 1204 / 1150)) - $80,000 =
$3,577.54
Therefore, a quarterly fee of $83,577.54 will be paid to the contractor for the December
2004 quarter.
Example 3
There are also other formulae for use in cost fluctuation adjustment clauses. For
example, the New Zealand standards for building and construction (NZS 3910:2003)
and for contract conditions for building and civil engineering construction (NZS
3915:2005) provide an appendix which covers cost fluctuation adjustment by
indexation (example 3 is reproduced from Appendix A of NZS 3910:2003 with the
permission of Standards New Zealand.) Accordingly, the amounts payable by the
principal to the contractor under the contract should be adjusted up or down by
amounts calculated in accordance with the following formula:
where:
C = cost fluctuation adjustment for the quarter under consideration
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Contract Indexation Guide for Businesses
V = valuation of work shown as payable in any payment schedule in respect of
work completed during the quarter under consideration subject to A3, but without
deduction of retentions and excluding the cost fluctuation adjustment
L = labour cost index; private sector: industry group – construction: all salary and
wage rates published by Statistics NZ, for the quarter under consideration
L'= index as defined under L but applying for the quarter during which tenders
close
M = producers price index; inputs: industry group – construction, published by
Statistics NZ, for the quarter under consideration
M'= index as defined under M but applying for the quarter during which tenders
close.
25