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Forecasting Exchange Rates for its Foreign Currency Fluctuation 
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Washington, DC 20548: 

United States Government Accountability Office: 

October 19, 2005: 

The Honorable Thad Cochran: 
Chairman: 
The Honorable Robert C. Byrd: 
Ranking Minority Member: 
Committee on Appropriations: 
United States Senate: 

The Honorable Kay Bailey Hutchison: Chairman: 
The Honorable Dianne Feinstein: 
Ranking Minority Member: 
Subcommittee on Military Construction and Veterans Affairs: Committee 
on Appropriations: 
United States Senate: 

The Honorable Jerry Lewis: 
Chairman: 
The Honorable David R. Obey: 
Ranking Minority Member: 
Committee on Appropriations: 
House of Representatives: 

The Honorable James T. Walsh: 
Chairman: 
The Honorable Chet Edwards: 
Ranking Minority Member: 
Subcommittee on Military Quality of Life and Veterans Affairs and 
Related Agencies: Committee on Appropriations: 
House of Representatives: 

Subject: American Battle Monuments Commission: New Approach to 
Forecasting Exchange Rates for its Foreign Currency Fluctuation 
Account: 

The conference report for the Fiscal Year 2005 Consolidated 
Appropriations Act required that we review the past and current 
methodologies used by the American Battle Monuments Commission (ABMC) 
and the Office of Management and Budget (OMB) to estimate exchange 
rates used in preparing the budgets for ABMC's foreign currency 
fluctuation account.[Footnote 1] This account is intended to maintain 
the spending power of funds appropriated for ABMC operations in the 
event that the U.S. dollar depreciates against the currencies used to 
pay for these operations, which include designing, constructing, 
operating, and maintaining permanent American military burial grounds 
in foreign countries. In light of recent low foreign currency 
fluctuation account levels, the appropriations committees' conferees 
were concerned with the failure of OMB to adequately address the effect 
of foreign currency rate fluctuations on ABMC in its original budget 
submission for fiscal year 2005, or through a supplementary budget 
request. 

In response to this mandate, we examined (1) ABMC's method of 
forecasting exchange rates in preparing budgets for the foreign 
currency fluctuation account prior to its fiscal year 2006 budget 
submission and OMB guidance on that method; (2) changes that occurred 
in the ABMC foreign currency fluctuation fund as the dollar depreciated 
in value relative to the currencies used by ABMC in its operations; and 
(3) changes that ABMC made in preparing its fiscal year 2006 budget 
submission. 

To accomplish these objectives we interviewed OMB officials and ABMC's 
budget officer, and reviewed ABMC documents and OMB and Department of 
Defense (DOD) budget guidance. We also reviewed balances of the ABMC 
foreign currency fluctuation account for fiscal years 2000-2005, levels 
of the euro-dollar exchange rate over the same period, and ABMC's 
budget request for fiscal year 2006. We conducted our work between 
April and September 2005 in accordance with generally accepted 
government auditing standards. 

Results in Brief: 

Prior to the budget proposal that it submitted for fiscal year 2006, 
ABMC used the same exchange rates as DOD did to estimate the amount of 
foreign currency per dollar for funding the foreign currency 
fluctuation account. In a prior report[Footnote 2] we explained DOD's 
approach, which allowed staff to exercise judgment in selecting often 
highly favorable exchange rates published in the DOD Program Budget 
Decision 660 (DOD PBD 660) for each fiscal year. We criticized this 
approach because it produced unrealistic results and allowed for 
substantial judgment and discretion in the selection of exchange rates 
for budgeting purposes. However, OMB concurred with ABMC and did not 
question this method. Further, OMB does not provide guidance, such as a 
central exchange rate forecast or a consistent forecasting method, for 
federal agencies to use in preparing their budgets. According to OMB 
officials, each agency is responsible for determining the appropriate 
exchange rate to convert its expected foreign currency spending into 
dollars for budgeting purposes. The administration does not publish 
foreign currency projections, according to OMB, because they could 
affect foreign currency markets. 

Beginning in fiscal year 2002, the euro appreciated substantially 
against the dollar and losses steadily decreased ABMC's currency 
fluctuation account as the commission increasingly drew upon it (see 
fig. 1). ABMC continued to use DOD PBD 660 to set foreign currency 
rates and did not include a request for an additional appropriation for 
the account as part of its budget submission for fiscal years 2003 and 
2004. Further, the President's budget did not request funding for the 
foreign currency fluctuation fund for fiscal year 2005. However, as 
fiscal year 2004 progressed, ABMC recognized that the account had 
fallen to a level that necessitated curtailing overall commission 
spending. Congress provided about $12 million in supplemental 
appropriations for fiscal year 2005. In the President's fiscal year 
2006 budget submission, $15.25 million was requested for ABMC's foreign 
currency fluctuation account. 

Figure 1: Euro-Dollar Exchange Rate and ABMC Foreign Currency 
Fluctuation Account, FY 2000-2005: 

[See PDF for image] 

[End of figure] 

In its budget submission for fiscal year 2006, ABMC stopped using 
exchange rates set by DOD PBD 660; instead, it used the exchange rate 
that prevailed on the date when it had to make its final submission to 
OMB. This method does not depend on staff judgment and discretion; we 
believe avoiding such judgment and discretion is appropriate in 
selecting exchange rates for budgetary purposes. Given the difficulty 
of forecasting exchange rates, this approach is reasonable. 

Background: 

ABMC was created in 1923 and, as of September 30, 2004, maintained 24 
cemeteries as well as 29 monuments, memorials, and markers 
commemorating the achievements in battle of the United States Armed 
Forces since 1917.[Footnote 3] All the cemeteries are located outside 
the United States and inter about 131,000 U.S. military war dead and 
U.S. civilians.[Footnote 4] Although ABMC receives appropriations in 
dollars, about 70 percent of its funds are expended in foreign 
currencies, principally the euro. ABMC also uses the British pound, the 
Mexican peso, the Philippine peso, and the Tunisian dinar. ABMC uses 
its budget dollars to purchase foreign currencies to pay a substantial 
amount of its salaries and expenses.[Footnote 5] 

In 1988, Congress created a foreign currency fluctuation account to pay 
for ABMC's day-to-day operations if--because of exchange rate 
fluctuations occurring after budget submissions to Congress--they 
exceeded dollar appropriations[Footnote 6][Footnote 7] According to OMB 
officials, few other federal agencies have similar accounts although 
the Department of State, the Peace Corps, and other agencies do engage 
in foreign currency transactions. Some of these federal agencies that 
use foreign currencies do not require large amounts of foreign 
currencies in relation to the size of their overall budgets and thus 
are more easily able to absorb the impact of a depreciating dollar. 
Most federal agencies have to absorb the effects of exchange rate 
fluctuation subsequent to budget approval; they do so by reallocating 
budgeted amounts or requesting supplemental appropriations. However, 
DOD does have a Foreign Currency Fluctuation Defense Account that is 
used to cover unforeseen losses due to foreign currency rate 
fluctuations.[Footnote 8] 

Before Fiscal Year 2006, ABMC Used DOD Method for Estimating Exchange 
Rates, Which Produced Unreliable Forecasts: 

Prior to the fiscal year 2006 budget, ABMC, with OMB agreement, used 
DOD PBD 660 to estimate exchange rates in formulating its budget 
request for the foreign currency adjustment account (see table 1). DOD 
PBD 660 outlined a method intended to address changes in the dollar in 
relation to other currencies after the President's budget was released 
so that the correct amount of dollars could be budgeted to maintain the 
purchasing power of the appropriation that was provided for in the 
budget. 

Table 1: Actual Average Euro-Dollar Exchange Rate Versus DOD PBD Rates, 
FY 2000-2005: 

[See PDF for image] 

Sources: DOD, ABMC, Federal Reserve, and GAO. 

[A] Calculated average during the fiscal year from the January 1, 2000 
inauguration of the euro to September 30, 2000. 

[B] Not applicable; these budgets were prepared prior to the 
inauguration of the euro. 

[C] Average calculated through June 30, 2005. 

Note: We calculated the actual average euro-dollar rate based on 
Federal Reserve data on foreign exchange rates. 

[End of table] 

In past years, to develop the exchange rates, DOD tracked foreign 
currency exchange rates in The Wall Street Journal on a daily basis 
during the months immediately preceding the budget submission and then 
selected the most favorable foreign currency exchange rates during this 
time frame. The most favorable rate was the rate that provided the 
highest amount of foreign currency per dollar. For the fiscal year 2004 
budget submission, DOD selected the most favorable rates from August 
through November 2002. Further, DOD did not revise its rates in its 
fiscal year 2005 budget submission. 

According to ABMC's budget officer and OMB officials, ABMC's use of DOD 
PBD 660 worked reasonably well when the dollar was not quickly 
depreciating. Moreover, OMB concurred with ABMC's use of DOD PBD 660 
and did not question this method. However, both ABMC's budget officer 
and OMB officials noted that ABMC's use of DOD PBD 660 led to serious 
problems beginning in fiscal year 2004. 

In particular, DOD PBD 660 did not anticipate the significant 
depreciation of the dollar against the euro (see again table 1). We 
discuss the effects of recent currency fluctuations in more detail in 
the next section of this report. 

We have criticized DOD's PBD 660 methodology.[Footnote 9] Exchange 
rates respond directly to events--tangible and psychological-- 
including inflation rates, business cycles, interest rates, balance of 
payment statistics, political developments, tax laws, stock market 
news, inflationary expectations, international investment patterns, and 
government and central bank policies. As a result, forecasting exchange 
rates is inherently difficult and the methods used to do so must 
address multiple and complex variables. In particular, we have noted 
that DOD's method did not produce exchange rate forecasts that would 
lead to realistic budgets. Unlike ABMC, DOD did continue to request 
funding for its currency fluctuation fund. As we reported previously, 
the use of the most favorable foreign currency rate underestimates the 
impact of foreign currency fluctuations and reduces the dollar amount 
in the foreign currency budget when the dollar depreciates relative to 
foreign currencies. Because the ABMC foreign currency fluctuation 
account is funded according to the exchange rate estimates, when the 
estimates are wrong ABMC's spending power diminishes and the commission 
must cut overall spending. 

[End of table] 

According to OMB officials, OMB does not provide guidance to federal 
agencies on how to handle foreign currency fluctuations in budget 
formulation, and each agency is responsible for determining the 
appropriate exchange rate for budgeting purposes. For example, OMB 
Circular A-11 does not provide guidance on addressing exchange rate 
fluctuations in budgeting.[Footnote 10] The administration does not 
publish foreign exchange projections because they could affect currency 
markets. According to OMB officials, agencies that have foreign 
operations have different amounts of currency exposure to different 
currencies. That is, each federal agency that operates outside the 
United States has its own mix of spending in foreign currencies, 
necessitating agency-specific approaches to accommodating exchange rate 
fluctuations in budgeting. According to these officials, at one time, 
OMB performed several broad reviews of individual agency approaches, 
but no common approach to budgeting for foreign currency risk was 
developed for the government as a whole. 

Declining Value of the Dollar Depleted ABMC's Foreign Currency; as a 
Result, the Account Required an Additional Appropriation: 

Because ABMC used the approach in DOD PBD 660 when the dollar was 
declining in relation to the euro and ABMC and OMB did not request 
appropriations for the fluctuation account in fiscal years 2004 and 
2005, ABMC had to curtail overall spending in fiscal year 2005. As we 
noted previously, the forecasts derived from DOD PBD 660 underestimated 
the dollar's decline relative to the euro. More specifically, ABMC 
experienced significant budget problems in fiscal years 2004 and 2005, 
when the dollar depreciated substantially against the euro. ABMC would 
not have been able to cover its foreign currency obligations under the 
estimates of the dollar's value incorporated in the foreign currency 
fluctuation account. The foreign currency fluctuation account suffered 
losses of more than $4.1 million in fiscal year 2003 and losses of more 
than $4.7 million in fiscal year 2004 and the account balance 
diminished to less than $1 million at the beginning of fiscal year 2005 
(see table 2). With roughly 70 percent of ABMC's spending in foreign 
currencies, and about 66 percent of its total budget allocated for 
payrolls issued in foreign currencies, the agency did not have any 
additional margin if the dollar depreciated substantially. 

Table 2: ABMC Foreign Currency Fluctuation Account Activity, FY 2000- 
2005: 

[See PDF for image] 

Sources: OMB and ABMC. 

[A] These numbers are as of August 31, 2005, and are unaudited. 

[B] Pub. L. No. 108-477 authorized $12 million in appropriations less a 
.0080 recission of $96,000. 

[C] Numbers shown reflect the net amount of gains or losses in the 
foreign currency fluctuation account and the amount of funds 
deobligated from prior years and transferred from ABMC's salaries and 
expenses account into the foreign currency fluctuation account. 
Parentheses indicate a loss. 

[End of table] 

According to ABMC's budget officer, because of the long time frames 
needed to prepare budgets and the uncertainty of currency forecasting, 
the commission could not have foreseen the dollar's depreciation during 
fiscal years 2004 and 2005. OMB officials and the ABMC budget officer 
acknowledged that neither agency requested an additional appropriation 
for ABMC's currency fluctuation fund in the fiscal year 2005 budget. 
However, during fiscal year 2005, Congress provided additional funding 
for the ABMC foreign currency account (about $12 million). OMB did not 
issue a Statement of Administration Policy or other communication 
objecting to this additional funding. 

ABMC Used a Different Method to Prepare Fiscal Year 2006 Budget Request 
for Foreign Currency Fluctuation Account: 

As a result of the problems incurred when using DOD PBD 660, beginning 
with its fiscal year 2006 budget submission, ABMC, with OMB agreement, 
began using the exchange rates (principally the euro-dollar rate) 
prevailing when final budget numbers must be entered into OMB's budget 
system[Footnote 11](see fig. 2). ABMC's budget request for FY 2006 was 
$35.3 million for salaries and expenses and $15.25 million for the 
foreign currency fluctuation account. In contrast to its previous 
method, ABMC's revised approach is reasonable in that it is 
nonjudgmental and has a transparent method--criteria that we believe 
are appropriate for selecting exchange rates for budgetary purposes. 
Further, ABMC and OMB officials told us that they are continuously 
evaluating the new ABMC method of budgeting for exchange rate changes 
as part of the ongoing budget review process. 

More specifically, ABMC and OMB officials told us that the rate they 
used in the fiscal year 2006 budget request for salaries and expenses 
was based on spending estimates in the foreign currencies, converted 
into dollars using the exchange rates prevailing during the budget 
formulation process in the summer of 2004. Then, when ABMC was required 
to submit its exchange rate estimate for the foreign currency 
fluctuation account, the commission applied the rate prevailing in 
December 2004. The euro-dollar rate used in the fiscal year 2006 budget 
formulation process for the ABMC foreign currency fluctuation account 
was 0.72 per $1.00. In contrast, the euro rate prevailing during July 
2004 was 0.81 per $1.00, illustrating the potential movement of 
exchange rates during preparation of a budget. 

Figure 2: Timeline for ABMC's Fiscal Year 2006 Budget Formulation: 

[See PDF for image] 

[A] Used to develop budget amounts for salaries and expenses. Average 
based on July 2004 data. 

[B] This number is the average for December 2004 and was used to 
develop the foreign currency fluctuation account budget amount. 

[End of figure] 

Similarly, DOD has changed its approach to forecasting exchange rates 
for budget purposes. Rather than using the most favorable or strongest 
value of the dollar, DOD recently selected a statistical method 
referred to as the "centered weighted average," which combines both a 
long-run average of exchange rates and the most recently observed 
exchange rates to predict future exchange rates. DOD chose this 
approach because it was based on historical and current data and could 
be universally replicated; therefore, it was not dependent on 
subjective judgment. We recently reported that this was also a 
reasonable approach for forecasting foreign currency rates and could 
produce a more realistic estimate than DOD's historical 
approach.[Footnote 12] 

Conclusions: 

ABMC has the important charter of overseeing cemeteries located outside 
the United States that inter about 131,000 war dead, including overseas 
memorials and markers that commemorate the achievements in battle of 
the United States Armed Forces since 1917. Most of its appropriated 
dollars must be converted and spent in foreign currencies. Recognizing 
the changing value of the dollar in relation to other currencies, a 
foreign currency fluctuation fund was created to maintain the spending 
power of appropriated funds. ABMC relied on DOD estimates of exchange 
rates in developing its budget requests for the fund. 

In fiscal year 2004 the balance in this account diminished to less than 
$1 million as the dollar continued to decline against the euro, forcing 
ABMC to curtail spending. The exchange rate estimates used in preparing 
the ABMC budget did not change while the dollar declined in value. The 
President's budget for 2005 did not request funding for this account. 
Congress provided supplemental appropriation for the account in fiscal 
year 2005. 

In the fiscal year 2006 budget, funds were requested for the foreign 
currency fluctuation account and this request was based on the exchange 
rate prevailing when the budget was finalized. This exchange rate 
approach has the advantage of being transparent and avoids the judgment 
that was incorporated in the DOD estimates that ABMC had used 
previously. Recognizing the need to avoid future problems, ABMC and OMB 
officials told us that they are continuously evaluating the new method 
of budgeting for exchange rate changes as part of the ongoing budget 
review process. 

Agency Comments: 

We provided a copy of a draft of this report to OMB and ABMC for 
comment. OMB and ABMC did not provide formal comments. Their staffs did 
provide technical comments that were incorporated as appropriate. 

We are sending copies of this report to the Secretary of the Treasury, 
the Director of the Office of Management and Budget, the Chairman of 
the American Battle Monuments Commission, and other interested parties. 
In addition, this report will be available at no charge on the GAO Web 
site at http://www.gao.gov. 

Should you or your staff have any questions concerning this report, 
please contact me at (202) 512-2717 or jonesy@gao.gov. Contact points 
for our Offices of Congressional Relations and Public Affairs may be 
found on the last page of this report. GAO Staff who made major 
contributions to this report were Patrick S. Dynes, James M. McDermott, 
and Charles W. Perdue. 

Signed by: 

Yvonne Jones: 
Director: 
Financial Markets and Community Investment: 

(250240): 

FOOTNOTES 

[1] Pub. L. No. 108-447; H. Rept. 108-792. 

[2] GAO, Review of DOD's Report on Budgeting for Exchange Rates for 
Foreign Currency Fluctuations, GAO-05-800R (Washington, D.C.: June 16, 
2005). 

[3] The Commission's enabling legislation is codified in 36 U.S.C. 
Chapter 21. 

[4] GAO, Financial Audit: American Battle Monuments Commission's 
Financial Statements for Fiscal Years 2004 and 2003, GAO-05-298 
(Washington, D.C.: Mar. 1, 2005). 

[5] Codified at 31 U.S.C. 2109. OMB officials noted that under the 
language authorizing its foreign currency adjustment account, DOD had 
substantially greater flexibility in managing the account than ABMC had 
with its smaller account. 

[6] The U. S. government routinely holds foreign currencies to fund its 
overseas operations. Foreign currencies acquired are either purchased 
with dollars from commercial sources or received without direct 
purchase for dollars. For example, non-purchase foreign currencies are 
received in exchange for agricultural commodities, in repayment of 
loans, and by other mechanisms. According to the Financial Management 
Service of the Department of the Treasury, between October 1, 2004, and 
March 31, 2005, the federal government reported $2.3 billion in foreign 
currency purchased from commercial sources and a balance of $162.5 
million as of March 31, 2005. See Financial Management Service, 
Department of the Treasury, Foreign Currencies Held by the U.S. 
Government: October 1, 2004 through March 31, 2005. 

[7] GAO-05-800R. 

[8] GAO-05-800R.

[9] Office of Management and Budget, Circular No. A-11: Preparation, 
Submission, and Execution of the Budget (Washington, D.C.: July 2004). 

[10] According to OMB, ABMC and OMB also review exchange rate trends to 
ensure that the exchange rates used do not represent short term spikes 
or drops in the dollar's value. 

[11] GAO-05-800R.