Defense Trade: Status of the Defense Export Loan Guarantee Program
(Letter Report, 12/21/98, GAO/NSIAD-99-30).

Pursuant to a congressional request, GAO reviewed the Department of
Defense's (DOD) Defense Export Loan Guarantee (DELG) Program, focusing
on: (1) the level of program activity to date; (2) the program's
financial status; (3) other sources of financing available to borrowing
countries; (4) comparing DELG Program characteristics with other U.S.
government export financing programs; and (5) examining issues related
to the planned fiscal year 1999 transfer of DELG Program
responsibilities within DOD.

GAO noted that: (1) since its implementation in 1996, the DELG Program
has guaranteed one loan and has not generated enough revenue in fees to
cover its operations; (2) the program's ability to attract future
activity to generate sufficient revenue for continued operations is
uncertain, since countries have other sources that offer financing at a
lower lost; (3) further, the availability of loan guarantees is one of
numerous factors that affect a country's decision to purchase U.S.
defense exports; (4) unlike the DELG Program, other U.S.
government-administered programs that offer direct loans or guarantees
for defense-related items are designed to operate with U.S. government
subsidies, which reduce financing costs to the purchasing countries; (5)
decisions on the scope and nature of continued DELG operations pose a
challenge to DOD; (6) a report on program operations and any recommended
changes has not been submitted to Congress, as required by law; (7) in
addition, the DELG Program has not been transferred within DOD as
originally planned under the Defense Reform Initiative; and (8)
uncertainty about future program responsibility may also be hampering
day-to-day operations.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-99-30
     TITLE:  Defense Trade: Status of the Defense Export Loan Guarantee 
             Program
      DATE:  12/21/98
   SUBJECT:  Foreign loans
             Foreign governments
             Foreign military assistance
             International economic relations
             Comparative analysis
             Government guaranteed loans
             Foreign military sales
             Foreign trade policies
IDENTIFIER:  DOD Defense Export Loan Guarantee Program
             Foreign Military Sales Program
             F/A-18 Aircraft
             DOD Foreign Military Financing Program
             Romania
             Thailand
             
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Cover
================================================================ COVER


Report to Congressional Requesters

December 1998

DEFENSE TRADE - STATUS OF THE
DEFENSE EXPORT LOAN GUARANTEE
PROGRAM

GAO/NSIAD-99-30

Defense Trade

(707335)


Abbreviations
=============================================================== ABBREV

  DELG - Defense Export Loan Guarantee
  DOD - Department of Defense
  DSCA - Defense Security Cooperation Agency
  ICRAS - Interagency Country Risk Assessment System

Letter
=============================================================== LETTER


B-280232

December 21, 1998

The Honorable Dale Bumpers
The Honorable Paul Sarbanes
United States Senate

The National Defense Authorization Act for Fiscal Year 1996 directed
the Secretary of Defense to establish a loan guarantee program for
the sale or long-term lease of defense articles and services to
eligible foreign governments.\1 The legislation required the
Secretary of Defense to charge fees to cover administrative costs and
potential U.S.  liability in the event of default on loan payments. 
Consistent with congressional intent, the Department of Defense (DOD)
established the Defense Export Loan Guarantee (DELG) Program in
November 1996 and designed it to operate at no cost to the
government.  The authorizing legislation also required the President
to submit a report to Congress by February 1998 that included an
analysis of the costs and benefits of the DELG Program and any
recommendations for modification of the program that the President
considers appropriate. 

In response to your request, we determined the status of the program. 
Specifically, we reviewed the level of program activity to date, the
program's financial status, and other sources of financing available
to borrowing countries.  As agreed with your offices, we also
compared DELG Program characteristics with other U.S.  government
export financing programs and examined issues related to the planned
fiscal year 1999 transfer of DELG Program responsibilities within
DOD. 


--------------------
\1 10 U.S.C.  2540(a). 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

Since its implementation in 1996, the DELG Program has guaranteed one
loan and has not generated enough revenue in fees to cover its
operations.  The program's ability to attract future activity to
generate sufficient revenue for continued operations is uncertain,
since countries have other sources that offer financing at a lower
cost.  Further, the availability of loan guarantees is one of
numerous factors that affect a country's decision to purchase U.S. 
defense exports.  Unlike the DELG Program, other U.S. 
government-administered programs that offer direct loans or
guarantees for defense-related items are designed to operate with
U.S.  government subsidies, which reduce financing costs to the
purchasing countries. 

Decisions on the scope and nature of continued DELG operations pose a
challenge to DOD.  A report on program operations and any recommended
changes has not been submitted to Congress, as required by law.  In
addition, the DELG Program has not been transferred within DOD as
originally planned under the Defense Reform Initiative.  Uncertainty
about future program responsibility may also be hampering day-to-day
operations. 


   BACKGROUND
------------------------------------------------------------ Letter :2

In the 1970s and 1980s, DOD guaranteed loans issued for weapons
exports and incurred significant costs when developing countries were
unable to repay.  Between 1974 and 1984, almost all foreign military
financing took the form of guaranteed loans provided through the U.S. 
government's Federal Financing Bank.  In the global recession of the
1980s, repayment of these loans was difficult for developing
countries.  Congress authorized debt refinancing and debt reduction
plans to mitigate these problems.  By 1990, DOD changed its financing
focus from guarantees to predominantly grants.  DOD's foreign
military financing currently consists of grants and also loans
subject to the Federal Credit Reform Act of 1990.\2

As worldwide military sales have declined in recent years,
competition in arms sales has intensified among major weapon
suppliers.  U.S.  defense companies have been concerned that they
have been at a competitive disadvantage because other exporting
nations provided government-backed financing, while the United States
did not.  Although only one of many variables in a buyer's decision,
official export financing support can be of particular importance in
an individual sale, such as when private institutions are unwilling
to offer long-term financing without a guarantee. 

The Secretary of Defense assigned responsibility for the new loan
guarantee program to the Under Secretary of Defense (Acquisition and
Technology), who placed the program in the office of the Deputy Under
Secretary of Defense for International and Commercial Programs. 
However, as part of the Secretary of Defense's 1997 Defense Reform
Initiative to restructure parts of DOD, responsibility for the
program was planned to transfer to the Defense Security Cooperation
Agency (DSCA) in fiscal year 1999.\3

Under the DELG Program, the Secretary of Defense may issue guarantees
against possible losses of principal and interest for loans provided
by private sector institutions to certain eligible sovereign nations. 
DOD guarantees defense export loans for up to the lesser of 85
percent of the contract value or 100 percent of U.S.  content
provided that the
U.S.  portion of the production cost of exported items is greater
than 50 percent.  The program covers eligible transactions under both
the Foreign Military Sales Program, administered by DOD, and U.S. 
defense companies' direct sales that are licensed by the U.S. 
Department of State.  Eligibility is limited to countries meeting
criteria defined by the program's authorizing legislation.\4 As of
January 1997, 39 countries were eligible for the DELG Program. 

DELG Program financing terms include disbursement periods, during
which only interest is charged, that extend as long as 5 years and
repayment periods up to 12 years.  Interest, based on a lender's cost
of funds plus an agreed percentage, will accrue on the outstanding
balance of the loan during the disbursement period and will be paid
at a minimum of every
6 months.  Repayment of principal must begin within 6 months of the
end of the disbursement period.  DOD determines the repayment period
based on the contract value, the useful life of the item, and the
purchasing country.  The borrowing nation must accept the loan as
sovereign debt and pay at least 15 percent of the contract price to
the supplier in cash, prior to disbursement of the guaranteed loan
amount or in incremental installments. 

DOD may respond to an application for a DELG loan guarantee in two
phases as requested by the applicant (see fig.1).  In the first
phase, DOD issues a letter of interest providing nonbinding
notification that it is willing to guarantee a loan and estimates the
costs to the borrower.  This notification does not obligate DOD to
provide a guarantee.  In the second phase, DOD issues a binding
commitment to guarantee the eligible loan.  However, applicants may
request final commitment from DOD without first obtaining a letter of
interest. 

   Figure 1:  DELG Application
   Process

   (See figure in printed
   edition.)

   Source:  DELG Program guidance.

   (See figure in printed
   edition.)



--------------------
\2 The purpose of the Federal Credit Reform Act of 1990 was to ensure
that the budget reflects a more accurate measurement of the
government's subsidy costs for federal direct loans and loan
guarantees and to permit better cost comparisons among credit
programs and between credit and noncredit programs. 

\3 DSCA (formerly the Defense Security Assistance Agency) is the
principal organization within DOD responsible for security assistance
program management and associated operational functions, including
financing. 

\4 By law, 10 U.S.C.  2540(b), a country must be (1) a member of the
North Atlantic Treaty Organization (NATO); (2) a designated major
non-NATO ally as of March 31, 1995; (3) a Central European country
that the Secretary of State has determined either has changed its
form of national government from a nondemocratic to a democratic form
since October 1, 1989, or is in the process of changing its form; or
(4) a non-Communist country that was a member of the Asia Pacific
Economic Cooperation as of October 31, 1993. 


   DELG PROGRAM HAS SEEN LITTLE
   DEMAND
------------------------------------------------------------ Letter :3

Consistent with congressional intent, DOD designed the DELG Program
to operate through various user fees to cover its operating costs and
the risk of potential default on loan payments by the borrowing
nation.  However, the program has collected little money in fees
because most eligible countries have not participated.  In the
authorizing legislation, Congress limited the number of eligible
countries to countries that are major allies or emerging democracies. 
Industry and banking officials we spoke with said that most of the
eligible countries can obtain financing at a lower cost or,
alternatively, they find the program unaffordable.  Therefore,
countries make little use of the DELG Program.  In addition, it is
unclear what impact export financing arrangements have on export
sales, because other factors may also affect a purchasing country's
decision on from whom to buy. 


      DELG PROGRAM WAS DESIGNED TO
      BE SELF-SUSTAINING
---------------------------------------------------------- Letter :3.1

The DELG Program was intended to be self-sustaining and therefore
user fees to borrowing nations were set at levels expected to cover
estimated program costs.  The borrower pays fees to cover
administrative costs and an exposure fee that reflects the risk of
default.  DOD calculates the exposure fee based on the loan's
repayment term, its disbursement schedule, the country's risk rating,
and the guaranteed loan's interest rate.  By law, the exposure fee
must be paid proportionately as the guaranteed loan is disbursed and
may not be included in the guaranteed loan amount. 

To initiate the program, DOD was authorized to provide $500,000 from
its operating funds for reimbursable start-up costs.  The authorizing
legislation provided that user fees for the DELG Program would be
used to reimburse the start-up costs.  As shown in figure 2,
borrowers pay administrative fees to a program account that is
recorded on budget and an exposure fee to a financing account that is
nonbudgetary and is used to record the cash flows associated with the
loan guarantee over its life.\5 In the case of defaults, the reserves
held in the financing account are used to make claim payments to the
lending institution.  If exposure fee estimates are accurate, the
financing account will have exactly the reserves needed to cover any
defaults that occur.  If exposure fees are not estimated correctly
and losses occur, additional funds from the general fund may be
necessary to cover losses.\6

   Figure 2:  DELG Program Cash
   Flow Under Credit Reform Act

   (See figure in printed
   edition.)


--------------------
\5 Nonbudgetary accounts may appear in the budget for informational
purposes, but the transactions are outside the budget because they do
not represent net budget authority but rather the means of financing. 

\6 The Federal Credit Reform Act of 1990 provides credit programs
with permanent indefinite budget authority to pay for subsidy
reestimates that may occur. 


      DELG PROGRAM GUARANTEED ONE
      LOAN AND ISSUED NINE
      NONBINDING NOTIFICATIONS FOR
      OTHER LOAN GUARANTEES
---------------------------------------------------------- Letter :3.2

Since its inception, the DELG Program has issued one loan guarantee
valued at about $16.7 million to support a U.S.  company's licensed
direct commercial sale of unmanned air vehicle and moving target
simulator systems to Romania.\7 In early 1997, AAI Corporation, a
U.S.  company, conducted negotiations with the Romanian government
for the contract.  According to company officials, financing was not
a factor in winning the contract award.  The Romanian government had
originally planned to pay for the purchase from its budget but
requested financing during contract negotiations.  As a result, AAI
Corporation sought a loan that would be guaranteed by the DELG
Program.  When the loan guarantee was approved, the exposure risk fee
was calculated at 21.23 percent of the guaranteed principal amount of
about $16.7 million, a fee of about $3.5 million.  Disbursement of
the loan began in July 1998, and it is planned to conclude in March
1999 according to DOD officials.  The Romanian government will have 5
years to repay the loan. 

Besides guaranteeing one loan, the DELG Program has issued
preliminary notifications that it is willing to guarantee loans for
nine other transactions.\8

These are valid for 6 months and then may be renewed.  According to a
DELG program official, some of the nine letters of interest are no
longer valid.  DOD officials said that they do not monitor the status
of contract awards and, therefore, do not know whether any of the
nine transactions will result in an eventual loan guarantee. 
However, if any of the letters of interest resulted in a guarantee,
then the DELG Program would receive additional fees.  Based on the
letters already issued, the DELG Program has indicated its
willingness to guarantee loans to Greece, New Zealand, South Korea,
Spain, Thailand, and Turkey.  The aggregate DELG guarantee amount for
the nine transactions is about $4.5 billion.  Examples of equipment
covered by the potential loan guarantees are radar systems and major
platforms such as military aircraft.  Some DOD and industry officials
stated that the letters of interest are used as a marketing tool so
that the potential purchaser can compare the DELG terms and
conditions with other available financing options. 


--------------------
\7 Defense appropriations acts have provided authority to DOD to
carry outstanding guarantees up to a total value of $15 billion. 

\8 Two letters of interest remained pending but not issued. 


      DELG HAS LIMITED FUNDING TO
      COVER FUTURE PROGRAM COSTS
---------------------------------------------------------- Letter :3.3

As authorized, the Secretary of Defense made available $500,000 for
expenses directly related to the administration of the DELG Program. 
This money, which came from DOD appropriated funds, was used for a
contract with a consulting firm to implement the program.  The
start-up costs are to be reimbursed to DOD's operations and
maintenance fund if and when the program has collected sufficient
fees.  To date, the start-up costs have not been reimbursed, and the
contract with the consulting firm terminated at the end of fiscal
year 1998.  DOD officials who provided policy oversight for the
program indicated that they did not charge time specifically to a
DELG account and that most of the daily operations, such as
responding to program inquiries and drafting letters of interest,
were covered by the outside consulting firm. 

About $125,000 in fees were collected as of October 1998.  The funds
are being held in a special receipt account until they are expended. 
Table 1 shows the types of fees charged to administer the program and
the amount collected. 



                                     Table 1
                     
                     DELG Fees to Cover the Administration of
                        the Program (from February 1997 to
                                  October 1998)

                                                                          Amount
                                                                          collec
Fee           Definition of fee             Policy                           ted
------------  ----------------------------  ----------------------------  ------
Administrati  Covers administration of the  3/8 of 1 percent of total     $62,47
ve            DELG guarantee during the     amount guaranteed and is           5
              loan disbursement and loan    paid at loan guarantee
              repayment period              closing

Commitment    Indicates that DELG has       1/8 of 1 percent a year is    14,997
              committed a portion of its    to be paid on the
              authorized contingent         undisbursed balance of a
              liability to a specific       guaranteed loan
              transaction

Processing    Covers the cost of            For letter of interest (14    48,000
              processing applications       applications): $1,250;
                                            for renewal or update of
                                            letter (1 letter amendment):
                                            $500;
                                            for final commitment (1
                                            final commitment application
                                            fee): $25,000;
                                            for Master Guarantee
                                            Agreements\a with lending
                                            institutions (2 agreements):
                                            $2,500

================================================================================
Total                                                                     $125,4
                                                                              72
--------------------------------------------------------------------------------
\a The Master Guarantee Agreement is an agreement between DOD and a
lender.  It provides the general terms and conditions applicable to
DELG guarantees. 


      DELG PROGRAM NOT
      COST-EFFECTIVE FOR MOST
      ELIGIBLE COUNTRIES
---------------------------------------------------------- Letter :3.4

Long-term viability of the program, as currently structured, depends
on a level of business that generates sufficient funds to cover daily
program operations and the likelihood of potential defaults. 
However, the program's ability to attract additional business is
unclear because, according to banking and industry officials with
whom we spoke, the program is not cost-effective for most of the 39
eligible countries.  The majority of these countries could either pay
for defense equipment from their own budgets or obtain favorable
financing from the private sector lending community.  The countries
with the highest risk of default on loans are the most likely to be
interested in the program because they can obtain longer terms and
lower interest rates than in the commercial market.  Banking and
industry officials also said that many banks do not finance defense
exports as a matter of policy, and those that do are not likely to
provide long financing terms for high risk countries. 

The risk rating of an eligible country is an important factor in
determining the exposure fee DOD will charge for guaranteeing a
specific transaction.  The program follows country risk ratings
resulting from the schedules and agreements set by the Interagency
Country Risk Assessment System (ICRAS).\9

For example, the program used the country risk rating for Romania as
one of the factors to calculate the exposure fee for the loan
guarantee. 

Based on our analysis, about one-third of the eligible countries may
consider DELG as a financing option because their high risk credit
ratings would likely foreclose other alternatives.  (See table 2 for
a list of eligible countries and those with high risk ratings.) Most
of the high risk countries eligible for DELG loan guarantees are in
Central Europe and represent newly independent nations that do not
have an established credit rating on the commercial market, according
to industry officials. 



                                     Table 2
                     
                     Countries Eligible for the DELG Program

                                              Number
                                                  of
Eligibility                                 countrie      Countries with high
criteria             Eligible countries            s      risk ratings\a
-------------------  ---------------------  --------  --  ----------------------
NATO member          Belgium, Canada,             15      Greece, Turkey
                     Denmark, France,
                     Germany, Greece,
                     Iceland, Italy,
                     Luxembourg, the
                     Netherlands, Norway,
                     Portugal, Spain,
                     Turkey, and the
                     United Kingdom

Major non-NATO       Australia, Egypt,             5      Egypt, South Korea
member               Israel, Japan, and
                     South Korea

Central European     Bulgaria, Croatia,           11      Bulgaria, Croatia,
countries            Czech Republic,                      Hungary, Latvia,
                     Estonia, Hungary,                    Lithuania, Poland,
                     Latvia, Lithuania,                   Romania, and Slovakia
                     Poland, Romania,
                     Slovakia, and
                     Slovenia

Non-Communist Asia   Brunei, Indonesia,            8      Indonesia, Philippines
Pacific Economic     Malaysia, New
Cooperation members  Zealand, Philippines,
                     Singapore, Taiwan,
                     and Thailand

================================================================================
Total                                             39      14
--------------------------------------------------------------------------------
\a Based on fiscal year 1998 country risk ratings. 

Company and banking officials cite the exposure fee structure as a
deterrent to program use.  By law, the exposure fee cannot be
financed as part of the guaranteed loan.  The borrowing country must
either pay for the fee out of its budget or seek other options to
finance the fee. 


--------------------
\9 Federal budgeting procedures require all U.S.  government agencies
and programs that provide cross-border loans, guarantees, or
insurance to have common standards for country risk assessment. 
ICRAS was developed for this purpose. 


      AVAILABILITY OF
      COST-EFFECTIVE FINANCING MAY
      NOT BE THE DECIDING FACTOR
      IN MAKING A DEFENSE SALE
---------------------------------------------------------- Letter :3.5

Even if the DELG Program provided more cost-effective financing,
other factors, including price, technical sophistication of
equipment, and offset arrangements,\10 influence a purchasing
country's decision when awarding a contract.  For example, offsets
are often an essential part of defense export sales, and demand for
such arrangements has increased in certain countries.\11

U.S.  defense companies are unable to quantify the impact of export
financing on sales but recognize that it is one of many factors
considered during source selection.  According to some U.S.  defense
companies, more purchasing countries are officially requesting
exporters to include financing arrangements in proposals for
contracts.  Financing provides purchasing countries with an option
for optimizing the use of available funds by stretching out payments
over time.  However, no U.S.  defense company official we spoke with
could offer an example of a purchasing country awarding a defense
contract based solely on financing considerations such as securing a
government guaranteed loan. 

Economic and political conditions also can affect a purchasing
country's decision on buying defense equipment.  For example, the
current Asian financial crisis has resulted in canceled or deferred
purchases.  Thailand could not uphold its contractual obligations for
its government-to-government purchase of an F/A-18 fighter package
because of economic hardship, and the Malaysian government announced
that defense spending would be deferred except for certain items
until the economy improves.  The availability of a DELG Program
guarantee would not likely alter these decisions. 


--------------------
\10 Offsets are the industrial and commercial compensation benefits
provided by sellers to foreign governments and firms as inducements
or conditions for the purchase of military goods and services. 

\11 For additional information on offsets, see Military Exports: 
Offset Demands Continue to Grow (GAO/NSIAD-96-65, Apr.  12, 1996). 


   THE DELG PROGRAM DIFFERS FROM
   OTHER U.S.  GOVERNMENT DEFENSE
   EXPORT FINANCING
------------------------------------------------------------ Letter :4

In addition to the DELG Program, the U.S.  government supports
defense-related export financing through the U.S.  Export-Import Bank
(Eximbank) for dual-use and drug interdiction equipment and through
the Foreign Military Financing Program, administered by DOD, for
direct commercial or government-to-government sales of defense
articles, services, and training.  Congress authorized loans to
Central European countries in fiscal years 1997 and 1998 as a new
initiative in the Foreign Military Financing Program.  As shown in
table 3, financing programs vary by legislative basis, eligible
products, levels of subsidization, types of financing offered,
authorized commitment or funding levels, program usage, and country
participation.  None of these programs reached their authorized
levels, and few countries are undertaking new commitments assisted by
these programs. 



                                     Table 3
                     
                       Program Characteristics of the DELG
                      Program, Eximbank Dual-Use Financing,
                          and Foreign Military Financing

Program
character                        Eximbank Dual-Use     Foreign Military
istics\a   DELG Program          Financing\b           Financing
---------  --------------------  --------------------  -------------------------
Legislati  Fiscal Year 1996      Public Law 103-428,   Foreign Assistance Act of
ve basis   National Defense      Oct. 31, 1994         1961, as amended,
           Authorization Act,
           sec. 1321             Public Law 105-121,   Arms Export Control Act,
                                 Nov. 26, 1997         as amended
           Fiscal Year 1999
           Defense                                     NATO Enlargement
           Appropriations Act,                         Facilitation Act of 1996
           sec. 8075

Purpose    "Level the            Supplement and        Support national security
           international         facilitate private    objectives of the United
           playing field" for    sector financing      States and its allies by
           U.S. defense                                providing security
           companies competing                         assistance
           for exports

Eligible   Defense articles,     Nonlethal dual-use    Defense articles,
products   services, or design   exports that have     services, and training
           and construction      military
           services              applications but
                                 primarily civilian
                                 use

Subsidiza  Zero subsidy for      Partially subsidized  Grants and partially
tion and   U.S.-backed loan      loan guarantees for   subsidized loans, with
types of   guarantees for        private sector loans  DOD as the lender
financing  private sector loans  and partially
                                 subsidized Eximbank
                                 loans

Authorize  Up to $15 billion of  Up to 10 percent of   Varies annually: fiscal
d          U.S. backing          the Eximbank's total  year 1997 authority
commitmen  (contingent           annual export         totaled $3.3 billion
t or       liability) for        financing authority
funding    outstanding
           guarantees

Program    At close of fiscal    Since 1995, 12        Fiscal year 1997 loan
usage      year 1998: 1 loan     transactions, both    subsidy authority: $58.2
           guarantee valued at   loan guarantees and   million (included in the
           $16.7 million         loans, with dual-     $3.3 billion total)
                                 use export value of
                                 about $264 million

Country    Limited by law to     Open to countries     In fiscal year 1997, five
participa  designated            subject to Eximbank   countries considered for
tion       countries. As of      limitations. As of    loans. Turkey and Greece
           fiscal year 1998,     fiscal year 1998,     received direct loans in
           Romania was the only  Brazil, Indonesia,    fiscal year 1997.
           borrowing country.    Romania, and
                                 Venezuela
                                 participated.
--------------------------------------------------------------------------------
\a Data as of fiscal year 1998 unless otherwise noted. 

\b Drug interdiction defense equipment is not in this category. 

The Eximbank is generally prohibited by law from financing exports of
defense articles except for nonlethal articles, categorized as
dual-use, intended primarily for civilian purposes.\12 The Eximbank
may also finance equipment and services on the U.S.  munitions
list\13 for drug interdiction purposes if the President determines
that the sale is in the U.S.  national interest.  The Foreign
Military Financing Program provides loans for eligible products
similar to the DELG Program but restricts direct commercial sales to
nonstandard defense articles and services.\14 The Foreign Military
Sales Program is the avenue through which most Foreign Military
Financing Program dollars are spent.\15

The DELG Program is not as advantageous to eligible borrowers as the
other U.S.  programs because the DELG Program requires a country to
fully cover its assessed risk of default as well as administrative
fees.  In contrast, the Eximbank offers the borrower an option to
finance the exposure fee that covers part of its assessed risk and
add the fee into the guaranteed loan amount.  The Eximbank subsidizes
the remaining amount needed to cover the risk of default.  According
to Eximbank officials, borrowers almost always choose to finance the
fee.  In the hypothetical example shown in table 4, the Eximbank
issued a loan guarantee for 85 percent of the contract price of $100
million and charged the borrower an exposure fee of 14 percent of the
85-percent loan guarantee.  The fee is rolled into the loan guarantee
amount. 



                                Table 4
                
                 Example of Hypothetical Eximbank Loan
                    Guarantee (dollars in millions)

Transaction feature                                             Amount
------------------------------------------------------  --------------
Contract price                                                  $100.0
Loan guarantee amount for contract                                85.0
Borrower's exposure fee                                           11.9
======================================================================
Total loan guarantee amount                                      $96.9
----------------------------------------------------------------------
The examples in table 5 contrast exposure fees for a given country
risk assessment category in the DELG Program and in Eximbank for the
same risk category and loan repayment term.  As the country's risk
rating and repayment period increase, the borrowing country has to
pay a higher exposure fee under both programs.  However, the fees are
higher under the DELG Program as compared to Eximbank's subsidized
program. 



                                Table 5
                
                    DELG and Eximbank Exposure Fees

                                             Exposure fee (percent of
                                                 loan guarantee)
                                            --------------------------
                                 Repayment
Borrowing country's risk            period
rating (1=low; 8=high)             (years)        DELG\a      Eximbank
----------------------------  ------------  ------------  ------------
4                                        5          5.38          2.75
6                                        5         13.63          4.14
6                                       12         22.55         11.41
7                                       12         33.50         17.11
----------------------------------------------------------------------
\a DELG examples are based on a 1-year disbursement period, the
lowest end of the DELG fee range. 

Source:  DELG Program guidance applicable for fiscal year 1998. 

Commitment levels in both the DELG Program and the Eximbank's
dual-use financing have been below authorized caps.  As of the close
of fiscal
year 1998, the total value of dual-use exports receiving Eximbank
financing since 1995 was about $264 million.  Also, the Eximbank has
financed four drug interdiction projects involving defense articles
since 1990.  Eximbank financing may be available, subject to
limitations, to almost 200 countries.\16 However, four
countries--Brazil, Indonesia, Romania, and Venezuela--received loans
or loan guarantees for dual-use exports between 1995 and 1998. 

The Foreign Military Financing Program's authority to issue new loans
also has not been fully used and few countries are undertaking new
commitments.  In fiscal year 1997, five countries--Greece, Turkey,
the Czech Republic, Poland, and Hungary--were considered for Foreign
Military Financing Program subsidized loans.  The Central European
countries did not participate because of (1) the perceived high
interest rate, (2) restrictions on countries' use of the loan, (3)
internal budgetary constraints, or (4) internal political conditions
such as the timing of legislative sessions.  In fiscal year 1998, the
appropriations act did not limit loan eligibility to specific
countries; however, DOD continued its initiative with the three
Central European countries and in 1998, one country, Poland,
indicated interest in accepting a loan because of a more favorable
interest rate.  DOD officials said they were planning to convert
unused fiscal year 1998 Foreign Military Financing loan subsidies to
grants. 


--------------------
\12 For additional information on the Eximbank, see U.S. 
Export-Import Bank:  Process in Place to Ensure Compliance with
Dual-Use Export Requirements (GAO/NSIAD-97-211, July 17, 1997) and
correspondence reporting on end uses of items financed and additional
financing commitments (GAO/NSIAD-98-244R, Sept.  1, 1998). 

\13 The U.S.  munitions list is published in the Department of
State's International Traffic in Arms Regulations. 

\14 Nonstandard items are those DOD items that do not have national
stock numbers.  However, a purchasing country may request in writing
exceptions from DSCA for the commercial procurement of standard DOD
items that have national stock numbers. 

\15 The Foreign Military Sales Program allows foreign government
purchasers to acquire U.S.  defense articles and services from DOD,
which manages the acquisitions using its established contracting
procedures. 

\16 The Eximbank makes available on its Web site a Country Limitation
Schedule.  The listing effective October 15, 1998, contains 199
countries and their limitations for financing. 


   RESOLVING UNCERTAINTY
   CONCERNING DELG PROGRAM
   RESPONSIBILITY POSES A
   CHALLENGE TO DOD
------------------------------------------------------------ Letter :5

DOD has not submitted a required report to Congress nor resolved
issues concerning programmatic responsibilities and resource
management of the program.  Under a DOD reorganization initiative,
the DELG Program was to transfer to DSCA in fiscal year 1999. 
However, such a transfer has not occurred and the conditions under
which a transfer would take place are not clear. 

The National Defense Authorization Act for Fiscal Year 1996 required
that the President submit to Congress a report on the loan guarantee
program, including an analysis of the costs and benefits of the
program and any recommendations for modification of the program that
may be appropriate, such as adding to the list of eligible countries,
and any proposed legislation necessary to authorize a recommended
modification.  The report assessing the program was required to be
sent to Congress by February 1998.  DELG Program officials said that
they have drafted a report for Congress and are coordinating it
through DOD.  The officials indicated that they had not prepared a
cost-benefit analysis of the program as part of the report. 
According to program officials, the report had not been submitted, in
part, because the law required the President to sign the report, a
time-consuming process.  They stated that they were taking the steps
necessary for the report to be signed by the Secretary of Defense,
which would require less review and coordination than a report signed
by the President. 

Under the Defense Reform Initiative, the transfer of the DELG Program
to DSCA was intended to consolidate programmatic responsibility for
financial matters associated with international weapon sales. 
However, officials are uncertain as to whether a transfer will
actually take place.  Senior DSCA officials said they view the
program as "broken" and have refused to accept it in its current
condition.  Furthermore, they said the Under Secretary of Defense for
Policy has prepared a memorandum citing that problems with the
program needed to be resolved.  DOD officials said that they may use
the existing user fees to award a contract to a consulting firm to
operate the program on an interim basis. 

Without any demand for the program, continued operations may not be
necessary.  However, without future activity and revenue, the
$500,000 start-up costs from DOD's operating funds cannot be repaid. 
In the meantime, DOD program officials view their role as one limited
to policy oversight.  It is unclear, therefore, how day-to-day
operations are being handled. 


   CONCLUSIONS
------------------------------------------------------------ Letter :6

Although designed to be self-sufficient, the DELG Program appears
unlikely to reach this goal in the near future without additional
loan guarantees.  Industry and banking officials indicated that the
program was too expensive to attract potential borrowing countries in
comparison to financing terms available from private sector sources
or their own budgets.  However, it is not clear what program
modifications would generate more activity, because financing is only
one of several factors a country considers when awarding a contract. 
Any examination of the steps needed to modify program operations
should be based on an assessment of the costs to the government in
taking those steps and the benefits associated with a more active
program.  DOD has an opportunity to reexamine the future of the DELG
Program in the required report to Congress.  The ongoing dispute
regarding program management responsibility may be hampering
day-to-day program operations. 


   RECOMMENDATIONS
------------------------------------------------------------ Letter :7

We recommend that the Secretary of Defense ensure that the required
report to Congress provides a cost-benefit analysis of the DELG
Program.  In addition, we recommend that the Secretary of Defense
clarify responsibility for staffing, managing, and providing
resources for the program. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :8

In commenting on a draft of this report, DOD stated that it plans to
submit a legislative proposal to terminate the program and believes,
therefore, that our recommendations are moot.  The existing law
requires that the President submit a report to Congress by February
1998 on the DELG Program, containing an analysis of the program's
costs and benefits.  This has not occurred.  Although in its
comments, DOD limited its discussion to the impact of program terms
and conditions of the program's operations, an analysis addressing
issues that we raise in our report, such as the use of export
financing by purchasing countries and by exporters, would also
contribute to the debate about the future of the program.  We have
deleted part of our original recommendation that called for DOD to
develop a recommendation on the future of the program.  However, our
remaining recommendations are still valid because DOD's proposal does
not relieve it from complying with the current legislation or
continuing sound management of current operations.  For example, DOD
has ongoing business such as the loan guarantee to Romania that
requires continued management until its conclusion.  DOD's response,
without attachment, is reprinted in appendix I. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :9

To determine the DELG Program's activity and financial status, we
examined DELG legislation, policy, loan guarantee, and budget
documents.  We interviewed past and present officials working on the
DELG Program, collected and analyzed budget documents, and discussed
the DELG budgetary accounts with officials from the DOD Comptroller's
Office, the Office of Management and Budget, and the Congressional
Budget Office.  We discussed with several banking and industry
officials the level of interest in the DELG Program as well as
alternative financing sources available to borrowing countries.  We
examined the country risk rating schedule for the 39 DELG-eligible
countries and the impact the country rating had on the cost of the
DELG loan guarantee to borrowing countries. 

To provide a broader context of information on U.S.  government
defense-related export financing, we compared the DELG Program with
DOD's Foreign Military Financing Program and the Eximbank's financing
for dual-use items.  We obtained information and program documents
from DOD and Eximbank officials on their financing programs.  We
reviewed and assessed various characteristics of all three financing
programs, including the governing legislation, program purpose, type
of financing provided, spending authority, eligible articles to be
financed, and country participation.  We also compared the impact of
subsidies on DELG and Eximbank loan guarantee exposure fees. 
Finally, we identified unresolved management issues regarding the
DELG Program and discussed them with DOD officials. 

We performed our work between March and October 1998 in accordance
with generally accepted government auditing standards. 


---------------------------------------------------------- Letter :9.1

We plan no further distribution of this report until 30 days from its
issue date unless you publicly announce its contents earlier.  At
that time, we will send copies of this report to the Chairmen and
Ranking Minority Members of the Senate Committee on Armed Services;
Subcommittee on Defense, the Senate Committee on Appropriations;
Subcommittee on Foreign Operations, Export Financing, and Related
Programs, the Senate Committee on Appropriations; Subcommittee on
International Economic Policy, Export, and Trade Promotion, the
Senate Committee on Foreign Relations; the House Committee on
National Security; Subcommittee on Foreign Operations, Export
Financing and Related Agencies, the House Committee on
Appropriations; Subcommittee on National Security, House Committee on
Appropriations; Subcommittee on International Economic Policy and
Trade, House Committee on International Relations; and Subcommittee
on International Operations and Human Rights, House Committee on
International Relations; the Secretary of Defense; the Director,
Defense Security Cooperation Agency; and the Director, Office of
Management and Budget.  We will make copies available to others upon
request. 

Please contact me on (202) 512-4841 if you or your staff have any
questions concerning this report.  Major contributors to this report
were Karen Zuckerstein, Anne-Marie Lasowski, and Anne Howe. 

Katherine V.  Schinasi
Associate Director
Defense Acquisitions Issues




(See figure in printed edition.)Appendix I
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
============================================================== Letter 


*** End of document. ***