American Battle Monuments Commission: New Approach to Forecasting
Exchange Rates for its Foreign Currency Fluctuation Account	 
(20-OCT-05, GAO-06-50R).					 
                                                                 
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. 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.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-50R 					        
    ACCNO:   A39901						        
  TITLE:     American Battle Monuments Commission: New Approach to    
Forecasting Exchange Rates for its Foreign Currency Fluctuation  
Account 							 
     DATE:   10/20/2005 
  SUBJECT:   Budget obligations 				 
	     Budgeting						 
	     Foreign currency					 
	     Foreign currency exchanges 			 
	     Foreign exchange rates				 
	     Depreciation					 
	     Appropriated funds 				 

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GAO-06-50R

United States Government Accountability Office Washington, DC 20548

October 20, 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.1 This account is intended
to maintain the spending power of funds

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

                GAO-06-50R American Battle Monuments Commission

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 report2 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

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

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

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 1917.3
All the cemeteries are located

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

outside the United States and inter about 131,000 U.S. military war dead
and U.S. civilians. 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.5

In 1988, Congress created a foreign currency fluctuation account to pay
for ABMC's dayto-day operations if-because of exchange rate fluctuations
occurring after budget submissions to Congress-they exceeded dollar
appropriations.6 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.7

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.

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

5Codified 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.

6The 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.

7GAO-05-800R.

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

                    Actual average DOD PBD 660 rates for 
               eurodollar exchange  euro-dollar exchange 
Fiscal year                rate                  rate 
          2000             1.0626a                     b 
          2001              1.1255                     b 
          2002              1.0877                1.1916 
          2003              0.9980                1.1386 
          2004              0.8216                1.1386 
          2005             0.7755c                1.1386 

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

aCalculated average during the fiscal year from the January 1, 2000
inauguration of the euro to September 30, 2000.

bNot applicable; these budgets were prepared prior to the inauguration of
the euro.

cAverage calculated through June 30, 2005.

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

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.8 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

8GAO-05-800R.

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.

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.9 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.

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

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

 Fiscal year        2000       2001       2002         2003         2004        2005a 
Account                                                                            
balance as of                                                            
  October 1   $4,517,181 $7,068,010 $9,614,297   $9,637,890   $5,532,057     $785,376
Appropriation         $0         $0         $0           $0           $0 $11,904,000b 
 Change (net                                                                          
foreign                                                               
  currency                                                               
gains,                                                                
 losses, and                                                             
 transfers)c  $2,550,829 $2,546,287   $ 23,593 ($4,105,833) ($4,746,681) ($6,552,436)
Account                                                                            
balance as of                                                            
September 30  $7,068,010 $9,614,297 $9,637,890   $5,532,057     $785,376   $7,400,011

Sources: OMB and ABMC.

aThese 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.

CNumbers 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.

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
system10(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

10According 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.

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
ï¿½0.72 per $1.00. In contrast, the euro rate prevailing during July
2004 was ï¿½0.81 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

aUsed to develop budget amounts for salaries and expenses. Average based
on July 2004 data.

bThis number is the average for December 2004 and was used to develop the
foreign currency fluctuation account budget amount.

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.11

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.

11GAO-05-800R.

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 [email protected]. 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.

Yvonne Jones Director Financial Markets

and Community Investment

(250240)

GAO-06-50R American Battle Monuments Commission

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