oversight

Foreign Assistance: Use of Host Country-Owned Local Currencies

Published by the Government Accountability Office on 1990-09-25.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

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                                                                                                   F’OREIGN
                                                                                                   ASSISTANCE
                                                                                                   Use of Host Country-
                                                                                                   Owned Local
                                                                                                   Currencies

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                                                                                                                                                              v)




                                                                                                                                                   IllIIllllII
                                                                                                                                                     142506




                                                                                                   General Accounting Office unless specifically
                                                                                                   approved by the Office of Congressional
                                                                                                   Relations.


GAO/NSIAI)-!M-2                                                1OIM
             United States
GAO          General Accounting Office
             Washington, D.C. 20648

             National Security and
             International Affairs Division

             B-238869

             September 26,199O

             The Honorable Dante B, Fascell
             Chairman, Committee on Foreign Affairs
             House of Representatives

             Dear Mr. Chairman:

             As requested, we are providing information about local currencies gen-
             erated as a result of U.S. assistance to foreign countries. This report
             summarizes the information we provided to your staff on January 10,
             1990, and includes some updated information. Specifically;the report
             addresses (1) ownership of the local currencies, (2) whether use of the
             currencies was consistent with U.S. assistance objectives, (3) the
             accountability requirements for local currency use, and (4) the potential
             for local currency generation and its use to affect host country econo-
             mies. As part of our review, we conducted field work in Tunisia and
             Zaire. These countries may not be representative of other countries
             receiving U.S. assistance, and therefore, conclusions on the use of local
             currency in these two countries cannot be generalized to other countries.


             Local currencies are generated primarily through financial or com-
Background   modity assistance provided under Public Law 480, the Economic Sup-
             port Fund, and the Development Fund for Africa. For example, under
             certain programs, the United States provides commodities to recipient
             governments. The governments sell the commodities, usually in the pri-
             vate sector, and the proceeds are local currencies that the government
             would not otherwise have had. In other cases, the United States pro-
             vides US. dollars as assistance, and aid agreements may require the
             recipient government to make available local currencies in an amount up
             to the value of the U.S. dollars. In fiscal year 1988, U.S. assistance-
             generated local currencies equaled $1.4 billion, about 48 percent of
             which was attributable to Public Law 480 programs, about 48 percent to
             Economic Support Fund financial contributions, and the remainder to
             the Development Fund for Africa. Data on 1989 generations was not yet
             available at the time of our audit work.

             The Congress defines the allowable uses for local currencies generated
             under each of these assistance programs. In general, most currencies are
             to be used for economic development purposes, and in support of U.S.
             development objectives. As a result of legislation and assistance agree-
             ments, the Agency for International Development (AID) and host country


             Page 1                                   GAO/NSIAD-SO-21OBR   Foreign   Assistance
                   B-238869                                                                    rl




                   officials jointly program, or negotiate and mutually agree on how these
                   local currencies are used. AID is responsible for ensuring that the local
                   currencies are used for the agreed upon purposes. Local currencies are
                   used for a wide variety of activities. They support development projects
                   or programs managed by AID or the host country. They are also used for
                   (1) general budget support in the host country, (2) the development
                   budget of a particular ministry or sector, or (3) AID mission operating
                   expenses. In some cases, local currencies can be used only after the host
                   country has made certain policy reforms as agreed upon with the United
                   States.


                   When the United States provides commodities or dollars as assistance to
Results in Brief   recipient countries, the local currencies that are generated from this
                   assistance are owned by the host country. The currencies are not an
                   added resource to the host country economy-the added resource is the
                   initial U.S. assistance provided in cash or commodities. However, this
                   transfer of local currencies from the private to the public sector allows
                   participating governments to retain control over the additional spending
                   power generated by the initial assistance.

                   In Tunisia and Zaire, local currencies were programmed in fiscal year
                   1988 for uses generally consistent with U.S. development objectives, and
                   we believe the currencies were generally used for the agreed upon
                   projects and programs. However, worldwide, even when local currencies
                   were programmed to support U.S. development objectives, AID’S over-
                   sight of local currency use has not always been adequate to reasonably
                   ensure that the currencies were consistently used for the agreed upon
                   purposes. AID is considering improved oversight guidance that will prop-
                   erly focus on the responsibilities and financial management capabilities
                   of the host government.

                   Generating and spending local currencies can contribute to inflation or
                   deflation in the recipient country. However, in most countries, it is
                   unlikely that, in 1988, generating and spending local currencies resulting
                   from U.S. assistance had a significant macroeconomic effect. Also, in
                   most countries, accumulations of unspent local currencies are not large
                   enough to have a significant future macroeconomic effect; although we
                   identified instances where the potential for a macroeconomic effect
                   exists.




                   Page 2                                   GAO/NSIAD-BO-210BR   Foreign   Assistance
                     B-238869




                     We believe that because the United States structures its assistance as a
Host Countries Own   grant or a concessional sale, it signals its intent that the host country
the Currencies       will own the currency generated from the assistance. Nevertheless, AID
                     is responsible for ensuring that the currencies are used for the agreed
                     upon purposes.


                          officials participate in decisions on how host country development
Local Currency       AID
                     resources are used as a result of joint programming requirements. AID
Programming in       officials told us that they hold discussions with host country officials on
Tunisia and Zaire    the proposed uses for local currencies throughout the year, not just
                     during formal agreement negotiations, However, it is not always pos-
Supported            sible to conclude that these discussions influence or change host country
Development          decisions and resource allocations. For example, Tunisian government
                     officials said that, even in the absence of joint programming, they would
Objectives           have used the local currencies generated from food aid in the same
                     way -in support of public works employment programs. Also, Tunisian
                     officials did not make those policy changes suggested by AID mission
                     officials that they believed were not in their best interest, even though
                     $3.0 million in local currency remained unused as a result.

                     In Tunisia, local currencies equal to $31.6 million were spent in fiscal
                     year 1988. The currencies funded government public works projects
                     designed to promote agricultural and rural development and provide
                     temporary employment to counteract the negative effects of Tunisia’s
                     structural adjustment program. Tunisian officials place a high priority
                     on these public works projects, and local currency support for the
                     projects fostered political good will between Tunisia and the United
                     States. Local currencies were also programmed to support a private
                     sector program and to speed policy reform consistent with U.S. objec-
                     tives that promote open market private sector activities.

                     In Zaire, local currencies equal to $24.3 million were spent in fiscal year
                     1988. More than 70 percent of the local currencies programmed in 1988
                     supported AID mission projects, primarily agricultural, rural develop-
                     ment, and health projects. Local currencies were also used for AID mis-
                     sion general operating expenses and mission costs associated with
                     supporting the development projects. Finally, local currencies were
                     programmed for budget support for the Zaire planning ministry and two
                     development ministries, and to support a special unit formed to manage
                     the local currencies generated by US. aid and that of six other donors.
                     Joint Zaire/AID accounting and monitoring requirements and AID tech-
                     nical assistance are intended to help reduce fraud and abuse in Zaire.


                     Page 3                                    GAO/NSIAD-SO-2lOBR   Foreign   Adratance
                       B-238869




                           is responsible for providing reasonable assurance that the local cur-
Accountability for     AID
                       rencies are used for the agreed upon purposes, even though the curren-
Local Currency         cies are owned by the host government. Our previous reports, listed on
                       the last page of this report, and AID Office of the Inspector General (IG)
                       audits have found that AID's monitoring was insufficient to provide rea-
                       sonable assurance that the currencies were properly used.

                       AID recognizes that the local currencies are vulnerable to waste, fraud,
                       and abuse. A 1989 survey of AID missions identified key weaknesses in
                       local currency oversight. As of April 1990, AID'S Office of Financial Man-
                       agement had proposed stronger and clearer guidelines to address these
                       weaknesses, including requiring formal and standard financial assess-
                       ments and audits of host country agencies that use local currencies. We
                       support this approach, because it focuses on improving the financial
                       management systems of these host country agencies. The guidelines also
                       touch on recommendations made in our previous reports.


                       Under certain conditions, local currency generation and spending may
Potential for          have a macroeconomic effect in the host country. For example, when
Macroeconomic Impact   commodities are sold in the private sector and the currencies are depos-
Is Small               ited in government accounts, the money supply contracts. This results in
                       a deflationary effect. When the currencies are spent, the money supply
                       expands, which may result in an inflationary effect. However, if the
                       generation and expenditure occur at about the same time, the infla-
                       tionary and deflationary effects are not likely to occur. When the cur-
                       rencies are not spent at about the same time as they are generated, the
                       larger the volume of local currencies involved, compared to the host
                       country money supply, the greater the potential that the local currency
                       activity can have a macroeconomic effect.

                       We believe it unlikely that, in 1988, generating and spending local cur-
                       rencies resulting from U.S. assistance had an adverse macroeconomic
                       effect in most countries. An analysis of the size of local currency pro-
                       grams generated from U.S. assistance and the timing of generations and
                       expenditures in 1988 among 47 countries indicated that, in general, cur-
                       rencies were spent soon after they were generated and the volumes of
                       local currencies were small compared to the host country money supply.
                       However, in six countries, the currencies were not spent soon after they
                       were generated and/or the volume of local currencies was large enough
                       to suggest that local currency activity could have had a macroeconomic
                       effect. Appendix I provides more details about the generation and use of
                       local currencies.


                       Page4                                     GAO/NSIAD90-210B&Fo~~Asslstance
                  B-236660




                      and the Department of Agriculture agreed with the findings and con-
Agency Comments   AID
                  clusions of this report in written comments, which are included in
                  appendixes II and III. Agriculture suggested minor modifications to
                  some of the report language which were incorporated where
                  appropriate.

                  As agreed with your Office, we plan no further distribution of this
                  report until 30 days after its issue date. At that time we will send copies
                  to the Administrator of AID, the Secretary of Agriculture, and appro-
                  priate congressional committees. We will also make copies available to
                  others upon request.

                  If you have any questions concerning this report, please call me at 275
                  6790. Major contributors to this report are listed in appendix IV.

                  Sincerely yours,




                  Harold J. Johnson
                  Director, Foreign Economic
                    Assistance Issues




                  Page 6
                                                                                                         r
    Conknts



    Appendix I                                                                                                  8
    Programming and Use Background                                                                            8
                        Scope and Methodology                                                                11
    of Local Currencies Who Owns the Local Currencies?                                                       13
                              Why Generate and Program Local Currencies?                                     16
                              How Are Local Currencies Used Worldwide?                                       18
                              Was Local Currency Use in Tunisia and Zaire Consistent                         20
                                  With U.S. Assistance Objectives?
                              Local Currency Accountability Requirements                                     30
                              Did Local Currency Use Impact on Host Country                                  33
                                  Economies?

    Appendix II                                                                                             39
    Comments From the
    Agency for
    International
    Development
    Appendix III
    Comments From the         GAO Comments
    Department of
    Agriculture
    Appendix IV                                                                                            44
    Major Contributors to
    This Briefing Report
    Related GAO Products                                                                                   48

    Tables                    Table 1.1: 1988 Local Currency Generation, Expenditure,                      36
3                                 and Pipeline as a Percent of Broad Money Supply
                i             Table 1.2: 1988 Net Local Currency Expenditure as a                          37
                                  Percent of Broad Money Supply




                              Page 6                                  GAO/NSIAIMO%lOBR   Foreign   Assistance
          Contenta




                                                                                          -
Figures   Figure I. 1: Background: Local Currency Generation and                                8
               Sources
          Figure 1.2: Fiscal Year 1988 Local Currency Generations                              9
          Figure 1.3: Scope and Methodology                                                   11
          Figure 1.4: Who Owns the Currencies?                                                13
          Figure 1.5: Why Generate and Jointly Program Local                                  15
               Currencies?
          Figure 1.6: How Are Local Currencies Used Worldwide?                             18
          Figure 1.7: Worldwide Local Currency Use in 1989                                 19
          Figure 1.8: Tunisia: Was Use Consistent With Assistance                          21
               Objectives?
          Figure 1.9: 1988 Local Currency Expenditures in Tunisia                          23
          Figure I. 10: Zaire: Was Use Consistent With Assistance                          26
               Objectives?
          Figure I. 11: 1988 Local Currency Expenditures in Zaire                          27
          Figure I. 12: Accountability Requirements                                        30
          Figure 1.13: Local Currency Factors Affect Host Country                          33
               Economies
          Figure I. 14: Did Local Currency Use Impact on Host                              36
               Country Economies?




          Abbreviations

          AID        Agency for International Development
          DFA        Development Fund for Africa
          EJF        Economic Support Fund
          IG         Office of the Inspector General


          Page 7                                    GAO/NSIAD-BO-210BR   Foreign   Arxdstance
                                                $
Appendix I

progr        amming and Use of Local Currencies


Flaure 1.1


        w      Background: Local Currency
               Generation and Sources

               Local currencies are
               generated when the United
               States provides
               *Food or other commodities,
                which the recipient sells
               *Dollars, and requires
                recipient to match with local
                currencies

                      A
                          Local currencies are generated through U.S. foreign assistance and food
Background                aid programs. The United States, for example, may provide agricultural
                          or other commodities to a developing country through a grant or conces-
                          sional sale. Local currencies are generated when the recipient govern-
                          ment sells these commodities. Also, when the United States provides
                          US. dollars as assistance, AID can require the recipient government to
                          make local currencies available for mutually agreed upon purposes in an
                          amount up to the value of the dollars.




                          Page 8                                 GAO/NSUD-90-210BR   Foreign   Assistance
                                     Appendix I
                                     Programming       and Use of Local Currenciee




Figure 1.2: Flrcrl Vear 1999 Local
Currency Oenerations
                                         ti                                                 ESF ($6!3.2 million)

                                                                                            3.9%
                                                                                            DFA ($52.7 million)



                                          47.9?6
                                                                                            Food Aid ($657.1 million)




                                     ;             \
                                                           I        _A



                                     Note: Dollar equivalents represented were calculated with average annual exchange rates.

                                     Local currencies are generated from three sources-the Economic Sup-
                                     port Fund @SF), the Development Fund for Africa (DFA), and food aid
                                     programs, as shown in figure 1.2. In fiscal year 1988, local currencies
                                     equivalent to $1.4 billion were generated from U.S. assistance. Complete
                                     data on fiscal year 1989 was not yet available during our audit work.

                                     The Foreign Assistance Act of 1961, as amended, authorizes ESF pay-
                                     ments to countries of particular security and political importance to the
                                     United States. Through FSF, local currencies may be generated from the
                                     U.S. assistance when the United States provides dollars as cash grants,
                                     or commodities through commodity import programs to a recipient
                                     country. At least 60 percent of the local currencies generated under
                                     commodity import programs are to be used to meet the development
                                     objectives targeted under the Foreign Assistance Act. In fiscal year
                                     1988, ESF generated an equivalent of $653 million in local currency, or
                                     48 percent of total generations.

                                     The DFA was first funded in fiscal year 1988. Similar to ESF, the United
                                     States provides dollars or commodities, which generate local currencies.
                                     All currencies must be used for development activities consistent with
                                     the Foreign Assistance Act and for necessary U.S. government adminis-
                                     trative requirements. In fiscal year 1988, DFA generated an equivalent of
                                     $53 million in local currency, or 4 percent of the total generations.



                                     Page 9                                                  GAO/NSLAD-90-210BR      Foreign    Assistance
Appendix I
Programming   and Use of Local Currencies




The United States provides food aid to developing countries under the
Agricultural Trade Development and Assistance Act of 1954, as
amended, commonly referred to as Public Law 480. Under title I of
Public Law 480, countries acquire agricultural commodities through
long-term, low-interest purchases. They sell the commodities in the pri-
vate sector to generate local currency, but must pay for most of the
purchases eventually in dollars. Title III is similar to title I, but forgives
the concessional credit repayment when local currencies are used for
specific development purposes. Under title II, the United States donates
food for humanitarian purposes, and some of this food is also sold by
recipient governments for local currency. Local currencies generated
from these titles must be used for economic development to benefit the
poor in areas such as agricultural and rural development and nutrition.

Finally, under section 416(b) of the Agricultural Act of 1949, the United
States donates surplus agricultural commodities to developing countries.
Proceeds from the sale of these commodities are to be used for develop-
ment programs or to benefit the needy. In fiscal year 1988, Public Law
480 and section 416(b) of the Agricultural Act of 1949 generated an
equivalent of $657 million in local currencies, or 48 percent of the total
generations.




Page 10                                     GAO/NSIAIMO-210BR   Foreign   Assistance
                      Appendix I
                      Programnhq   and Use of Local Currencies




Fiaure 1.3


       GAQ Scope and Methodology


             @Workdone in Washington,
             Tunisia, and Zaire
             @Focusedon host country-
             owned local currencies
             l Limited analysis to 1988
              currency uses
             *Did not conduct an account-
              ability and control audit
                      We conducted our review in Washington, D.C., and in Tunisia and Zaire.
Scopeand              In Washington, D.C., we interviewed officials from AID, AID'S IG, and the
Methodology           Departments of State and Agriculture. We reviewed evaluations and
                      studies of the major assistance programs that generate local currencies.
                      We focused solely on local currencies generated from U.S. assistance and
                      owned by the host country. Unless otherwise specified, all references to
                      local currencies in this report refer to these U.S.-generated currencies.

                      Our field work was performed in Tunisia and Zaire because these coun-
                      tries generate local currencies from at least two types of US. assistance,
                      and differ substantially in their use of local currencies. We interviewed



                      Page 11                                    GAO/NSLAD-SO-2lOBR   Foreign   Assistance
Appendix I
Frogramndng   and Use of Local Currencies




AID mission and US. Embassy officials, United Nations Development
Program officials, representatives from private accounting firms, and
host country officials from the Ministries of Planning, Finance, Foreign
Affairs, Treasury, Central Bank, and Agriculture. We reviewed project
documents, evaluations, assistance agreements, planning documents,
and International Monetary Fund and World Bank papers, and visited
project sites in Zaire. We focused on fiscal year 1988 because complete
data for 1989, including macroeconomic information, was not yet avail-
able during our audit work.

To determine the potential macroeconomic effect of generating and
spending local currencies associated with U.S. assistance, we analyzed
the volume of local currency activity relative to host country money
supply and the timing of expenditures and generations worldwide. We
used local currency data on fiscal year 1988 actual expenditures, as
reported in 1991 Annual Budget Submissions for 66 countries with local
currency programs. We used economic data extracted primarily from
the International Monetary Fund’s International Financial Statistics.
Adequate economic data was not available for 8 of the 66 countries. In
addition, we discussed host country monetary policy with government
officials in Tunisia and Zaire. We discussed our findings with AID and
International Monetary Fund economists.

We were limited in performing our work. We could not perform a world-
wide analysis of local currency use because local currency programming
decisions and reporting and monitoring requirements are decentralized
and the needed data was not centrally available. We discussed accounta-
bility issues with AID program and IG officials and reviewed previous
audits and reports, but we did not conduct an audit of local currency
controls and accounting systems in Zaire and Tunisia. While the case
studies in Tunisia and Zaire provide some examples of how local curren-
cies are programmed and of the advantages and disadvantages of the
current system, the results cannot be generalized to other countries. We
did not assess the effectiveness of the programs supported by local
currencies.

Our review was performed from August 1989 to April 1990 in accor-
dance with generally accepted government auditing standards. AID and
the Department of Agriculture provided written comments on a draft of
this report, which are included in appendixes II and III.




Page 12                                     GAO/NSIAD-BO-210BR   Foreign   Assistance
                      Appendix I
                      Programmhg   and Uee of Local Cum&m




   G&I       Who Owns the Currencies?

         l   Host countries own the
             currencies generated from
             U.S. assistance
         l    Local currencies must be
             jointly programmed
         @AID must ensure that local
          currencies are used for the
          agreed purposes



                      When the United States provides dollars or commodities as part of its
Who Owns the Local    assistance program, the local currencies generated from this assistance
Currencies?           are owned by the host governments. We believe that because the United
                      States structures its assistance as a grant or a concessional sale, it
                      manifests its intent that the currencies generated from the assistance
                      will be owned by the host government.

                      Nevertheless, as a result of program legislation and assistance agree-
                      ments, AID and the host country jointly program, or negotiate and mutu-
                      ally agree on how the currencies will be used. AID is responsible for



                      Page 13                                 GAO/NSIAMO-210BR   Foreign   Assistance
Appendix I
Programming   and Use of Local Currencies




ensuring that the currencies are used for the agreed upon purposes.
Because each country’s development needs and resources differ, AID has
delegated responsibility to negotiate and monitor currency uses to its
overseas missions. An interagency committee in Washington, DC.,
reviews and approves proposed Public Law 480 agreements and local
currency uses, but overall, mission officials have much flexibility in
selecting and monitoring projects and programs using local currency.

When the host country and AID mission agree that local currencies can
be managed by the AID mission, the currencies are placed in a trust
account and are used primarily for mission administrative costs.
Because the currencies are held in trust, AID missions must report to the
host government on the uses of the trust funds. Currencies used for mis-
sion administrative costs are primarily generated through ESF or DFA.
Currencies generated through Public Law 480 must be used for develop-
ment purposes.




Page 14                                     GAO/NSIAD-BO-21OBRForeign   Assistance
                          Appendix I
                          Progmmmlng   and Use of Local Currencies




Flgure 1.5


       w         Why Generate and Jointly
                 Program Local Currencies?

             l   Generation generally provides
                 AID and/or host country with
                 resources for development
             l   Joint programming provides AID
                 with opportunities for input
                 into host country budget
                 allocations
             l   Joint programming fosters
                 dialogue

                          Local currencies are not an added resource to the host country
Why Generate and          economy-the added resource comes with the initial U.S. assistance pro-
Program Local             vided, whether cash or commodities. However, the local currencies gen-
Currencies?               erated through this assistance represent a transfer of existing resources,
                          in this case, host country currencies, from the private to the public
                          sector, and allow participating governments to retain control over the
                          additional spending power generated by the initial assistance. For
                 Y        example, when the host country sells U.S.-provided commodities in the
                          private sector, the government obtains local currencies it would not
                          otherwise have had. The currencies provide host country officials with



                          Page 16                                    GAO/NSIAlMO-210BR   Foreign   Assistance
Appendix I
Programming   and Use of Local Currencies




financial resources to acquire locally available goods and services to
support programs and projects. Host government and U.S. officials in
Zaire and Tunisia view host country-owned local currency as a valuable
developmental resource.

Joint programming is designed to provide AID with an opportunity to
influence host country development decisions by negotiating and mutu-
ally agreeing on local currency use with host government officials. Some
AID officials told us that this fosters an ongoing dialogue, because they
hold discussions with host country officials on the proposed uses for
local currencies throughout the year, not just during formal agreement
negotiations.

In practice, however, we found that joint programming may or may not
alter the host government’s spending decisions. In Zaire, for example,
both AID and some Zaire officials said that joint programming helped to
ensure that development projects were funded, and that, in the absence
of joint programming, they had no assurance that local currencies would
be programmed for development purposes.

In Tunisia, on the other hand, we concluded that these discussions were
not the deciding factor in host country decisions or resource allocations.
Tunisian government officials said that even in the absence of joint pro-
gramming, they would have used the local currencies generated from
food aid in the same way because the projects funded by local currencies
are very important to the government. However, we were told that even
though the projects would have been funded, available local currencies
allowed Tunisia to expand the size of the projects.

Also, in Tunisia we learned that joint programming for policy reform
does not always lead to policy change. In 1988, Tunisia did not make
policy changes suggested by AID mission officials because Tunisian offi-
cials felt these changes were not in their country’s best interest at the
time. This resulted in the equivalent of $3.0 million of local currencies
left unprogrammed.

Some U.S. and host country officials, and others studying foreign assis-
tance programs, have argued that the local currency generated from
U.S. assistance should not be jointly programmed and that AID should
not then be responsible for oversight of its use, for various reasons. As
previously stated, joint programming may not alter the spending deci-
sions of the host country, and in some cases, AID and the host country



Page 16                                     GAO/NSIAD90-210BR   Foreign   Assistance
Appendix I
Prograndng   and Use of Lmal Currenclea




cannot agree on uses for the currencies until after significant and pro-
tracted negotiations. Also, because the currencies are owned by the host
country and are not an added resource to the host country economy,
some argue that the country should be permitted to dispose of the cur-
rencies as it sees fit. They stress that under Public Law 480 title I food
aid, countries must now repay the United States for the agricultural
commodities received, although at a concessional rate, and that addi-
tional conditions on the assistance are excessive. Finally, when countries
are participating in an economic stabilization program, using local cur-
rencies for new economic development projects or programs could run
counter to the common stabilization requirements of austerity and fiscal
restraint.

Joint programming fosters dialogue between host country and U.S. offi-
cials and helps to ensure that those local currencies required by legisla-
tion to be used for economic development purposes are indeed
programmed for those purposes. By working with the host government,
AID can provide guidance and assistance in determining the best use of
the resources.




Page 17                                   GAO/NSIAD-SO-210BR   Foreign   AssM.ance
                          Appendix I
                          Programming   and Use of Local Currencies




Figure 1.6


       w         How Are Local Currencies
                 Used Worldwide?

             l   AID development projects
             l   Host country development
                 projects/programs
             l   Host country budget support
             l   Trust funds and other
             l   Policy reform


                          Local currencies may be used for a wide range of activities. They may be
How Are Local             programmed in direct support of AID or host country development
Currencies Used           projects or programs. Local currencies may be used to support the host
Worldwide?                country’s general budget or the development budget of a particular min-
                          istry or sector. Some local currencies are managed by the AID mission as
                          a trust fund, and are usually used for mission operating expenses.In
                          some cases, local currencies are released only after the host country has
             ”            made certain policy reforms as agreed upon with the United States.




                          Page 18
                                           Appendix   I
                                           From           and Use of Local Currendee




                                           The appropriateness of using local currencies not earmarked for devel-
                                           opment for host country budget support has been recently debated.
                                           Some argue that local currencies should be used solely for economic
                                           development purposes, rather than to support the recurring expenses of
                                           host governments. In addition, when local currencies are used for host
                                           country budget support, it is often difficult for AID to ensure proper
                                           accountability for the use of the funds because host government
                                           accounting and control systems may not be adequate. On the other hand,
                                           some argue that when countries are participating in an economic stabili-
                                           zation or restructuring program, it may be more appropriate to use local
                                           currencies for budget support than for new economic development
                                           projects or programs that could undermine efforts to maintain austerity
                                           and fiscal restraint. Also, budget support may be appropriate when a
                                           country has a sound development plan consistent with U.S. objectives
                                           and allocates its resources accordingly.


Figure 1.7: Worldwide Local Currency Use
In 1989



                                                             7                             Eer   (Drought Relltaf. Monitoring, etc.)




                                                                       24Oh -          -   AID PmjecWPrograms




                                                                                           Host Country ProjecWPrugrams




                                           Page 19                                          GAO/NSIAMO-2lOBB       Foreign   Assistance
                        Appendix I
                        Pcogramndng   and Use of Lo&   Currendee




                        Figure I.7 shows how local currencies have been used worldwide, as
                        reported to AID'S Office of Financial Management in a 1989 survey. Data
                        was not readily available to assess, worldwide, the extent to which these
                        uses were consistent with U.S. assistance objectives. Such determina-
                        tions, because of the decentralized decision-making and monitoring
                        aspects of the program, can be made only at individual missions,


                        Our work in Tunisia and Zaire indicated that the local currencies were
Was Local Currency      programmed to be used for purposes consistent with U.S. assistance
Use in Tunisia and      objectives. Also, based on our field work, AID IG audits, and independent
Zaire Consistent With   pgro ram evaluations, we believe that the local currencies expended in
                        fiscal year 1988 generally were used for the agreed upon projects and
US. Assistance          programs, However, we did not conduct an accountability and control
Objectives?             audit to determine the level of assurance that local currencies in those
                        countries were used for the specified purposes. Also, when local curren-
                        cies are used for budget support in Zaire, the currencies are not moni-
                        tored beyond their disbursement to the proper government account.




                        Page 20                                    GAO/NSIAD9O%1OBR   Foreign   AssMance
                          Progmmming   and Use of Lwal   Currendes




Figure I.8


        GAQ Tunisia: Was Use Consistent
            With Assistance Objectives?
             l   Generally consistent
             l   Currencies were used to:
                 *Promote agricultural and rural
                  development
                 @Cushion negative impact of ’
                  structural adjustment
                 @Fosterpolitical good will
                 *Promote export development
                 @Speedpolicy reform/budget
                  support

Local Currency Use in     In fiscal year 1988, local currencies helped reduce the negative impact
Tunisia                   on employment from Tunisia’s economic structural adjustment program
                          and the effects of severe drought conditions. These currencies also sup-
                          ported rural public works projects designed to increase agricultural out-
                          puts and promote rural development, supported the development of
                          livestock forage reserves, fostered political goodwill, and hastened
                          policy reform. However, $3 million of local currencies that AID hoped to
                          spend to promote policy reform were left unspent because Tunisian offi-
                          cials did not want to make some of AID’S proposed policy reforms to
                          Tunisia’s agricultural credit fund at the time they were proposed.



                          Page 21                                    GAO/NSIAD-BOSlOBR   Foreign   Assbtance
Appendix I
F9ogrammhg   and Use of Local Currencies




Tunisia is a lower middle income developing country, and the govern-
ment places a high priority on structural adjustment (e.g. restructuring
its economy to provide more opportunities for export-oriented growth).
Tunisia’s adjustment program is aimed at reducing the deficit and gov-
ernment spending, removing price controls, and liberalizing investment
and foreign exchange controls. Tunisian officials are very concerned
about high unemployment resulting, in part, from their adjustment pro-
cess and the severe drought Tunisia experienced in 1987-89. AID mission
officials believe that the Tunisian government is capable of and com-
mitted to setting sound economic development priorities. According to
AID and Tunisian officials, there is little disagreement on general devel-
opment priorities.

AID  revised its assistance strategy for Tunisia in mid-1987. It no longer
emphasizes traditional infrastructure and institutional development,
but, instead, stresses economic reform in support of Tunisia’s structural
adjustment. AID'S strategy is to provide Tunisia with balance-of-payment
relief through EsF-funded commodity import programs and Public Law
480 title I concessional food credits, while using local currencies to pro-
mote policy reform and to support government programs.

In 1988, Tunisia received a total of $42.4 million in U.S. assistance,
including $31.6 million through Public Law 480 titles I and II food aid,
$10.8 million in ESF commodities, and a small amount ($28,000) in devel-
opment assistance. Tunisia generated about $30 million in local currency
in fiscal year 1988 from these programs, according to mission officials.
The amount of local currencies generated and jointly programmed does
not always equal the value of the assistance provided in any given year.
It is not uncommon to generate local currencies in fiscal years following
the receipt of the assistance, especially when commodities such as food
aid are shipped or arrive in-country near the end of the fiscal year. In
fact, in 1988, the U.S.-Tunisia Public Law 480 title I agreement was
amended twice in the last half of fiscal year 1988.




Page 22                                    GAO/NSIAD-90-210BR   Foreign   Assistance
                             Appendix I
                             ProgramtUg        atlU Use of Local Currencies




Plgunl.#z1@88LourlCurroncy
tixpondltum InTunlrlr
                                                                                  Forage Reserves ($4.0 million)




                                                                                  5.?Oh
                                                                                  Export Promotion ($1.8 milliin)




                                       81.5%        l                         -   Public Works/Employment ($25.7 million)




                             Local currencies equivalent to $3 1.5 million were expended in Tunisia in
                             fiscal year 1988, as shown in figure 1.9.

Useof FoodAid43enerated
                      LocA   Local currencies spent from food aid-generated funds in fiscal year 1988
currency                     were used to support key Tunisian government rural public works
                             projects. The projects were designed to directly increase the produc-
                             tivity and income of the rural poor by providing temporary “safety net”
                             employment for those adversely affected by Tunisia’s structural adjust-
                             ment program and the severe drought. The projects supported US.
                             assistance objectives by promoting agricultural and rural development
                             activities essential to increased agricultural production, such as soil and
                             water conservation, desert control, and reforestation projects.

                             Local currency support for the public works projects fostered political
                             goodwill between Tunisia and the United States. Tunisian officials value
                             ongoing U.S. support for these projects because they view them as key
                             to the success of structural adjustment. By providing employment, the
                             officials believe the projects cushion the negative effects of adjustment
                             and help prevent or forestall social unrest. In fiscal year 1988, local cur-
                             rency generated from U.S. assistance funded more than 23 percent of
                             the largest set of projects, which absorbed about 20 percent of Tunisia’s
                             unemployment.




                             Page 23                                               GAO/NSIAlMO-210BR      Foreign   Assistance
                         APW*       1
                         prorpammine    and Use of Local Currencies




Useof ESF-Generated
                 Local   Local currencies generated from ESF commodity import programs were
Currency                 used to support a Tunisian government agricultural development pro-
                         gram, a government private sector program, and to promote policy
                         reforms consistent with Tunisia’s adjustment program and U.S. open
                         market private sector development objectives.

                         Local currencies supported a government livestock forage reserve pro-
                         gram. Tunisia’s livestock population dwindled as a result of the drought,
                         and this program was designed to increase the availability of forage
                         supplies for farmers affected by the current and future droughts.

                         In late 1988, AID provided $1.8 million in local currencies to a Tunisian
                         government export risk insurance company. In exchange, the govern-
                         ment company agreed to increase its data base on non-traditional, but
                         promising, markets in Latin America, Sub-Saharan Africa, and Asia.

                         Also during 1988, the AID mission offered the equivalent of $6.0 million
                         in local currencies to support Tunisia’s leading agricultural credit pro-
                         gram, in exchange for four policy changes intended to improve the
                         credit program’s financial status and to increase credit opportunities for
                         poor farmers. Tunisian officials agreed to two of the proposed
                         changes-to reduce subsidized lending to politically influential wheat
                         farmers and to purge uncollected loans more than 3 years old. However,
                         the officials maintained that the other two changes-reducing adminis-
                         trative banking charges and establishing a more rigorous collections
                         system-were not in the government’s best interest at the time. As a
                         result, the mission released half of the requested funds, approximately
                         $3.0 million in fiscal year 1989. The local currencies that were not
                         released remained unused in a special account at the Central Bank, and
                         had not been reprogrammed as of November 1989, according to AID offi-
                         cials. Tunisian government officials said they were already considering
                         these reforms independently, and probably would have made the same
                         changes on their own, but would have waited a little longer to do so.

                         EsF-generated local currencies were also to be used for an AID agricul-
                         tural development project. In 1988, the AID mission and the Tunisian
                         government established a project to analyze and formulate agricultural
                         policy consistent with the objectives of Tunisia’s structural adjustment
                         program. AID mission officials anticipated funding certain studies and
                         projects with local currencies generated from commodity import pro-
                         grams As of August 1990, no local currencies had been used for this
                         project, according to an AID mission official.



                         Page 24                                      GAO/NSIAD-8@21OBB   Foreign   A~Mance
                           Appendix I
                           Programmlng   and Uee of Local Currender




Flguro 1.10


       w          Zaire: Was Use Consistent
                  With Assistance Objectives?

              l   Generally consistent
              l   Currencies were used for:
                  mAIDdevelopment projects
                  @AIDmission support
                  *Zaire budget support
              l   Program designed to cut
                  fraud and abuse


                           In addition, some local currencies from prior year agreements remain
                           unprogrammed or unexpended. We were told by Central Bank officials
                           that Tunisia’s monetary authorities do not undertake compensatory
                           monetary actions when currencies such as these are withdrawn from
                           the money supply, either by increasing available credit or printing addi-
                           tional currencies. Therefore, unused local currency in Tunisia represents
                           a real loss to the money supply.




                           Page 26                                    GAO/NSIAIMO-21OBR   Foreign   Assistance
                                                                                                   ,


                        Appendix I
                        Frogrammhg   and Use of I.ocal Currendea




Local Currency Use in   In fiscal year 1988, local currencies generated from US. food aid and ESF
Zaire                   programs to Zaire were used in support of U.S. assistance objectives.
                        Spending went primarily to finance the local costs of AID development
                        projects, AID mission costs, and general budget support of the Zaire gov-
                        ernment. Although the currencies are used for AID projects, they are
                        owned by the host country, and AID and Zaire officials jointly manage
                        the currencies’ use. According to both U.S. and Zaire officials, this has
                        helped to reduce fraud and abuse, and foster better accountability con-
                        trols and procedures.

                        Zaire has one of the lowest per capita income levels among African
                        countries. Presently, Zaire faces a growing external debt burden, depen-
                        dence on commodity exports with unstable prices, physical infrastruc-
                        ture deterioration, and inadequate public investment. Zaire implemented
                        an economic stabilization program in 1983. However, in 1986 and 1987,
                        the government undertook excessive deficit spending, and solid gains
                        from the stabilization program eroded. In 1987, the World Bank and the
                        International Monetary Fund withheld further loans until the govern-
                        ment re-established its stabilization program in early 1989, but balance-
                        of-payments support was again withheld in 1990 due to excessive gov-
                        ernment spending. The most recent stabilization program emphasizes
                        reducing the budget deficit, restructuring and improving public sector
                        management, improving the business climate, and improving the trans-
                        portation network. AID assistance objectives include economic restruc-
                        turing and policy dialogue, increasing agricultural productivity, and
                        improving farm-to-market access, health and population planning.

                        In 1988, Zaire received $42.2 million in US. assistance, $29 million from
                        DFA, and $13.2 million from Public Law 480. Zaire generated an
                        equivalent of $30.9 million in local currency from title I of Public Law
                        480 and ESF commodity import programs. As in Tunisia, some of these
                        generations were from prior year commodity import programs, and
                        some local currencies from fiscal year 1988 assistance would not be gen-
                        erated until future fiscal years.




                        Page 26                                    GAO/NSLAD-f)O-21OBR   Foreign       Amiatance
                                     Appendix I
                                     Programmhg   and Use of Local Currencies




Expendlturer   in Zaire
                                                                                    AID Mission Support ($3.4 million)

                                                                                           of Zaire Budget Support ($2.2
                                                                                    million)


                                                                                    Budget Support: Training Institutions and
                                                                                    Other ($1.5 million)




                                                                70.6%-          -   AID Development Projects ($17.2
                                                                                    million)




AID Development           Projects   Figure I. 11 shows how $24.3 million in local currencies was spent in
                                     Zaire in fiscal year 1988. More than 70 percent of the local currencies
                                     supported dollar-funded AID development projects. These were primarily
                                     agriculture and rural development projects aimed at increasing food
                                     production, raising national incomes, and improving nutrition. Other
                                     projects focused on child survival strategies, family planning, and
                                     acquired immunodeficiency syndrome (AIDS) prevention. Some local
                                     currencies were used to support selected development projects in trans-
                                     portation, infrastructure, local private voluntary organizations, and the
                                     Peace Corps. Specifically, local currencies in support of AID development
                                     projects were used to purchase locally available goods, such as fuel and
                                     vehicles, and for training and salaries. Also, currencies were used to
                                     supplement the low salaries of Zaire government workers assigned to
                                     AID projects. In addition, AID and Zaire officials have agreed to place
                                     local currencies in high yield term deposits when generations tempora-
                                     rily exceed expenditures. In 1988, $4.1 million in local currency was
                                     deposited in term accounts due to high generations from prior year
                                     programs.



                                     Page 27                                         GAO/NSLAD-90-21OBR    Foreign   Assistance
                 Appendix I
                 Programmbg   and Uae of Local Currencies




                 AID officials saw many benefits in using local currencies to support
                 dollar-funded AID development projects. According to mission officials,
                 restrictions on spending appropriated dollars do not apply to local cur-
                 rencies; therefore, using local currencies provides more flexibility to
                 respond to project needs. Also, local currencies can be used from one
                 year to the next without reobligation, and can be invested in short-term
                 deposits when there is a periodic surplus.

                 However, the AID IG criticized the AID mission in Zaire for a lack of gui-
                 dance on procurement practices when using local currencies. AID IG audi-
                 tors noted that project officials did not always document that multiple
                 sources of supply had been sought for commodity purchases, and recom-
                 mended that the mission prepare guidance to establish standard pro-
                 curement procedures. Mission officials agreed to prepare additional
                 guidance, although they maintained that flexibility is a key advantage
                 to local currency use.

MissionSupport   The next largest share of local currency spending (14 percent) was for
                 mission operating expenses and program support for the various offices
                 managing the AID development projects. AID projects and the mission
                 itself depend, to some extent, on local currencies for operating expenses.
                 Mission planning documents for fiscal years 1990 and 1991 indicated
                 that a loss of local currencies without an increase in dollar resources for
                 AID development projects would prevent the mission from managing its
                 current project portfolio.

BudgetSupport    Local currencies were also used for the government of Zaire’s budget
                 support. Zaire’s planning ministry received funds for general expenses
                 and planning, as well as operating expenses for a special office, the Sec-
                 retariat of Counterpart Funds. The AID mission does not monitor the use
                 of local currencies for budget support beyond ensuring that they are
                 deposited into the proper government account, according to mission offi-
                 cials. The Secretariat, staffed with 30 people, was formed to manage
                 local currency resources generated by nonproject assistance programs,
                 funded through the United States and six other donors. In addition, the
                 Ministries of Health and Agriculture received local currency support, as
                 did a few training institutions and local private voluntary organizations.

                 According to AID officials, the Zaire government has a history of corrup
                 tion and a lack of control over the use of public funds. By using local
                 currencies for AID projects, the officials said, they can closely monitor
                 local currency use and ensure spending for development purposes. A



                 Page 28                                    GAO/NSLALMO-210BR   Foreign   b&ance
Appendix I
Progmnmlng   and Use of Local currender




 6387 AID IG audit found that the Zaire mission had an effective local cur-
 rency audit system in place and, during our visit, AID officials were
 taking further steps to ensure that projects were maintaining adequate
controls over local currencies. Both AID and Zaire officials stated that
joint accounting and monitoring requirements help reduce fraud and
 abuse.

To further improve accountability, AID officials said they work closely
with Secretariat of Counterpart Funds officials to improve oversight
capabilities. AID monitors Secretariat reports, works with officials to
improve report reliability, and provides formal training to Zaire govern-
ment officials. Local currencies were used to purchase computers for the
Secretariat, and AID’S software system for local currency accounting was
being translated into French for use by the Secretariat, according to AID
officials. However, the volume of currencies managed by the Secretariat
in 1988 was small (2.2 percent) relative to Zaire’s overall expenditures.
As a result, although local currency monitoring requirements may have
contributed to fiscal responsibility within the Secretariat, they have not
necessarily had an effect on the overall government of Zaire’s financial
management capabilities or systems.




Page 29                                   GAO/NSIAD@O-21OBB   Foreign   AmMance
                           Appendix I
                           Programming   and Use of Local Currencies




Figure 1.12


       m          Accountability Requirements


              l   AID management and ‘IG differ
                  on accountability
              l   Local currencies are vulnerable
                  to misuse
              l   Focus should be on host
                  country financial management
                  capabilities


                               must ensure that local currencies are used for the purposes outlined
Local Currency             AID
                           by the Congress and in the aid agreements. However AID and its IG differ
Accountability             on the degree of accountability and control AID missions should exercise
Requirements               over local currencies. Our previous reviews and AID IG audits have found
                           that local currencies are vulnerable to misuse in many countries, and AID
                           is considering additional oversight requirements to strengthen assur-
                           ances that local currencies are properly used.

                           Legislation requires that most host country-owned local currencies be
                           used for development purposes. AID guidance provides missions with
                           flexibility in determining the degree of oversight necessary to provide



                           Page 30                                     GAO/NSIAD-BO-210BR   Foreign   Assistance
Appendix I
Progmnndng   and Use of Local Currencies




reasonable assurance that the local currencies are used for the intended
purposes. The guidance permits missions to vary their oversight,
depending on their involvement in programming the local currencies and
their assessment of the management capabilities of the host country.

AID   management and the AID IG differ on the extent of accountability and
control AID missions should exercise over these local currencies. AID offi-
cials stated that the disagreement over the necessary level of accounta-
bility has created frustration and uncertainty at AID missions. AID argues
that, although it must be satisfied that local currencies are used for
appropriate purposes, host countries, and not AID, ultimately should be
accountable for the proper use of the currencies because they own them.
AID officials maintain that increasing demands for accountability create
friction with the host government because government officials view the
currencies as their own. For example, language inserted in Public Law
480 title I agreements in recent years permits U.S. officials to audit host
country records. We found that Tunisian officials strongly objected to
this provision, which they viewed as obtrusive and unnecessary. Also,
some AID officials have told us that they simply do not have enough
staff to significantly increase their local currency monitoring.

AID'S  IG believes that AID missions must maintain full financial accounta-
bility for the local currencies, because they are generated from U.S.
assistance. Based on this criterion, IG audits have found that many AID
missions, because of accounting and monitoring weaknesses in the mis-
sion or in the host government, cannot always assure that local curren-
cies are properly used. Our previous reviews also found that because of
inadequate accounting, monitoring, and reporting systems, missions
could not always determine whether withdrawals and disbursements
were made for agreed purposes. Also, we found in a recent review of
assistance to El Salvador that mission officials and IG auditors do not
always interpret AID guidelines similarly.

AID officials acknowledge that improvements could be made in some
areas, while still holding the host country ultimately accountable. A
1989 AID survey of mission procedures identified several key problems.
AID officials told us that they are considering issuing additional over-
sight guidance intended to address these problems and decrease the vul-
nerability of local currency to misuse. The changes include
strengthening host country reporting requirements and mission verifica-
tion procedures for local currencies held in special accounts, requiring




Page 31                                    GAO/NSlAD-90-210BR   Foreign   Assistance
Appendix I
Progmnunhg   and Use of Local Currencies




audits of host country agencies managing the accounts and the organiza-
tions receiving the funds, and requiring formal and standardized finan-
cial assessments of host country agencies managing the accounts and
those receiving the funds, when necessary.

On April 18, 1990, we testified before the Subcommittee on International
Economic Policy and Trade, House Committee on Foreign Affairs, in
support of these changes. The audits and the formal financial assess-
ments could be funded with local currencies, which would result in
improved accountability without further taxing scarce mission
resources. The proposed changes would help to place the focus for local
currency accountability oversight on assessing and improving host
country agency financial management systems overall, rather than on
individual misuses and deficiencies.




Page 32                                    GAO/NSIAD-90-21OBR   Fore&n   Assistance
                       Appendix I
                       Frogranunhg   and Use of Local Currencies




Figure 1.13


       GM Local Currency Factors
          Affect Host Country Economies
              Local currencies can impact on
              host country economies,
              depending on:
              @Timebetween generation
              and expenditure
              l Local currency volume
                relative to money supply
              @Hostgovernment monetary
              policy

                       Generating and spending local currencies can have a macroeconomic
Did Local Currency     effect on the host country economy, depending on (1) the time elapsed
Use Impact on Host     between the generation and expenditure of local currencies, (2) the size
Country Economies?     of local currency generations and expenditures compared to certain
                       macroeconomic variables such as money supply, and (3) the monetary
                       actions taken by the host government to compensate for potentially
                       adverse effects.

                       When a recipient country sells U.S.-provided commodities (normally to
                       the private sector) in exchange for local currencies, the currencies are



                       Page 33                                     GAO/NSIAD-z)o-21OBR   Foreign   Assistance
                                                                                            ,



Appendix I
Programmhg     and Use of Local Currencies




withdrawn from the private sector and deposited in a government
account, usually in the central bank.’ As a result, the money supply con-
tracts, resulting in a deflationary effect. On the other hand, when these
local currencies are spent, the money supply expands, which may result
in an inflationary effect.

The potential macroeconomic effect of this local currency generation
and spending can be offset if spending closely approximates genera-
tions. If the generation and expenditure of local currencies in these
countries occur at about the same time, then the contraction and expan-
sion effects may cancel out any net macroeconomic effect. Am’s overall
guidance to missions states that local currencies should be disbursed as
quickly as is consistent with sound programming and prevailing eco-
nomic conditions in the recipient country.

Currencies are not always timely spent and, in some cases, they accumu-
late over a period of years. The volume of local currency generated and
spent influences whether this activity is likely to have a macroeconomic
effect. When the volume is small, relative to certain macroeconomic
variables such as a country’s broad money supply,2 the macroeconomic
effect may not be discernible. However, the larger the volume, the
greater the potential that this activity can have a significant
macroeconomic effect in the host country. These macroeconomic effects
may not always have an adverse effect on the host country economy.
For example, generating, but not spending, local currency may reduce
any existing inflationary pressures. However, if these accumulated cur-
rencies, sometimes referred to as the “pipeline,” are then spent over a
short period of time, they can have an inflationary effect, depending on
the volume of the accumulation.

Finally, host country monetary policy can affect the impact of local cur-
rency activity. When commodities are sold and the money supply is
reduced, government monetary authorities can take compensatory
action to offset this reduction by increasing available credit, or even
printing more currency. On the other hand, when the local currencies
are spent and the money supply expands, monetary authorities can take
compensatory action by restricting available credit. The monetary

’ In Zaire, local currencies generated from U.S. assistance are deposited into a government account at
a commercial bank.

2Broad money supply primarily includes currency and checking and savings accounts owned by the
general public. There are numerous macroeconomic variables that could be used for this comparison.
We chose broad money supply because it is a commonly used indicator of an economy’s financial size.



Page 34                                                  GAO/NSIAD-BOflOBR        Foreign   Assistance
                                 Appendix I
                                 Programming   and Use of Local Currencies




                                 authorities of the individual country will determine whether, and at
                                 what point, these actions are taken.

Figure 1.14


       0           Did Local Currency Use impact
                   on Host Country Economies?
               l   Overall macroeconomic impact
                   unlikely in 1988 because:
                   4olume was relatively small
                   Gurrencies were generally
                    spent soon after they were
                    generated
               lPotential exists in some
                countries
               lOther donor currencies can be
                a factor
               @AIDguidance is minimal
Unlikely Macroeconomic Impact    Using data on the 1988 volume and the timing of currency expenditures
From U.S.-Generated Currencies   for 47 countries, we assessed the potential for local currencies generated
                                 from U.S. assistance to have a macroeconomic impact on host country
                                 economies. First, we examined whether local currency activity was large
                                 enough to have a potential macroeconomic effect by calculating, for
                   4             1988, the amount of local currency generated, spent, and the resulting
                                 year-end accumulations as a percent of host country broad money
                                 supply for the 47 countries where data was available. As illustrated in
                                 table I. 1, on average, the generation, spending, and resulting pipeline


                                 Page 36                                     GAO/NSIAD-!bOH)ISOBR Foreign   Assistance
                                                                                                                                           .



                                           Appendix       I
                                           procprunmine       and Use of Local Currencies




                                           were near or less than 2 percent of the broad money supply. There is no
                                           generally accepted threshold beyond which the volume of local currency
                                           generations and expenditures is large enough to have a significant effect
                                           on a country’s economy. However, it is unlikely that local currency gen-
                                           erations and expenditures of this size in and of themselves would have a
                                           significant macroeconomic effect in these 47 countries.
Table 1.1: 1988 Local Curronoy
QOnOratlOn,  Expondlturo, and PipOlIn I#   Figures    in percent
a Percent of Broad Money Supply
                                                                                                                               Pipeline
                                                                               Generation             Expendlture              year end
                                           Average for 47 countries            1.81                   1.77                     2.02
                                           Countries with significant          Costa Rica 9.0         El Salvador 10.4         Costa Rica 12.0
                                           ratios                              Bolivia 7.8            Costa Rica 9.1           Lesotho 6.9
                                                                               El Salvador 6.8
                                           Note: Individual countries are listed if the percent of local currency activity compared to the broad
                                           money supply is more than two standard deviations from the mean.

                                           Table I. 1 shows that local currency generation ratios in Costa Rica,
                                           Bolivia, and El Salvador; spending ratios in Costa Rica and El Salvador;
                                           and the pipeline ratios in Costa Rica and Lesotho were substantially
                                           larger than the average. We do not know whether these volumes are
                                           large enough to have had a discernible macroeconomic effect in these
                                           countries because we did not do an in-depth analysis in each country.
                                           But, the large local currency ratios identify countries where the poten-
                                           tial may exist for local currency generations and expenditures to have a
                                           macroeconomic impact. For example, if the pipeline in Costa Rica were
                                           spent over a short period of time, the volume of accumulation is large
                                           enough to suggest that this expenditure could have a discernible infla-
                                           tionary effect on the country’s economy.

                                           We also calculated for these 47 countries whether local currencies were
                                           spent at about the same time that they were generated, using 1988
                                           expenditures minus generations.3 If currencies are spent soon after they
                                           are generated, the macroeconomic effect can be negated. When calcu-
                                           lated as a percent of the broad money supply, the data in table I.2 shows
                                           that on average, these countries spent a mere 0.06 percent more than
                                           they generated. With this, we concluded that, because most local curren-
                                           cies generated in 1988 were also spent in 1988, missions were in compli-
                                           ance with AID guidance and possible macroeconomic effects were
                                           cancelled out. Therefore, in most cases, generating and spending local

                                           3Annual figures for expenditures less generations were the only readily available data. We do not
                                           know if this is the optimal period of time to consider.



                                           Page 36                                                    GAO/NSIAD-30-21OBR         Foreign       Assietance
                                     Appemdix I
                                     Programming    and Use of Local Currencies




                                     currency from U.S. assistance most likely did not have a macroeconomic
                                     effect.

Table 1.2: 1988 Net Local Currency
Expenditure a8 a Percent of Broad    Figures in percent
Money Supply                                                                                          Expenditure Less Oeneration
                                     Average for 47 countries                                                                   -0.04
                                     Countries with significant ratios                                El Salvador                   3.6
                                                                                                      Madagascar                  -3.6
                                                                                                      Bolivia                     -3.7
                                                                                                      Malawi                      -5.1
                                     Note: Individual countries are listed if the percent of net local currency expenditure compared to the
                                     broad money supply is more than two standard deviations from the mean.

                                     For example, as shown previously in table I. 1, in Costa Rica the timing
                                     of 1988 generations and spending offset possible macroeconomic effects.
                                     Even though the relative size of generations (9 percent) and expendi-
                                     tures (9.1 percent) were substantially larger than the average, expendi-
                                     tures exceeded generations by only 0.1 percent. By spending the local
                                     currencies in 1988 close to the time they were generated, the potential
                                     macroeconomic effect has been minimized. However, in El Salvador,
                                     spending outpaced generations, and the relatively large ratio suggests
                                     that this may be an example of where spending could have had an infla-
                                     tionary effect.

                                     Finally, as shown in table 1.2, in Malawi, Madagascar, and Bolivia, the
                                     volume of local currencies generated and not spent, compared to the
                                     broad money supply, deviated significantly from the average. These
                                     unspent currencies may have reduced inflationary pressures in these 1
                                     countries, However, the resulting currency accumulations could con-
                                     tribute to inflation at a later date if care is not taken in planning and
                                     monitoring future use. We did not conduct an in-depth analysis of mone-
                                     tary policy or other macroeconomic factors in these countries, and do
                                     not know whether local currency generation and expenditure actually
                                     did have a macroeconomic impact.

MacroeconomicEffect in Tunisia       We analyzed (1) the volume of local currencies relative to the money
andZaireUnlikely                     supply, (2) the time between generations and expenditures, and (3) host
                                     government monetary policy in Tunisia and Zaire. We believe that AID'S
                                     programming and expenditure of host country-owned local currencies,
                                     in fiscal year 1988, most likely did not have a significant macroeconomic
                                     effect.




                                     Page 37                                                    GAO/NSIAIMO-210BR         Foreign   Amistance
                         Appendlx I
                         Frogranuning   and Use of Local Currencies




                         In Tunisia, the ratios of local currency generation, expenditure, pipeline,
                         and timing of expenditure compared to broad money supply, were all
                         under one percent and it is unlikely that local currency generation and
                         expenditures would have had a discernible macroeconomic impact.

                         In Zaire, we found that the ratio of local currency expenditures to
                         money supply was almost 6 percent. However, the mission in Zaire,
                         working with government officials, instituted a planning and monitoring
                         system, which ensured that the local currencies were spent soon after
                         they were generated, thereby mitigating possible macroeconomic effects
                         and the need for compensatory monetary actions.

Potential Exists for a   Although in most cases, U.S.-generated local currency amounts were
Macroeconomic Impact     small in 1988 and currencies were spent soon after they were generated,
                         local currency activity could have a macroeconomic effect in some coun-
                         tries. We identified countries where the potential existed for local cur-
                         rency generations and expenditures to have had a macroeconomic
                         effect. However, we did not perform in-depth analyses in these coun-
                         tries. Also, the combined generations and expenditures of local curren-
                         cies from other donor assistance can be large and could have a
                         significant macroeconomic effect. For example, in Zaire in 1989, local
                         currencies generated from U.S. assistance comprised less than 40 per-
                         cent of total local currencies generated from bilateral donors, according
                         to a planning ministry official. This does not include local currencies
                         generated through World Bank assistance. Although our analysis
                         showed no likely macroeconomic effects when considering U.S.-gener-
                         ated local currencies alone, we did not determine the combined effect
                         considering other donor generations and spending.

                         AID  recognizes that local currency generation and spending can have a
                         macroeconomic effect. AID guidance calls for spending local currency as
                         quickly as possible, given conditions in the host country and considering
                         stabilization agreements and sound monetary policy. However, the gui-
                         dance does not provide further detail on what factors to consider in ana-
                         lyzing host country conditions and monetary policy, or on appropriate
                         mission responses in those cases where it is not possible to spend local
                         currencies quickly. Also, guidance is silent on those examples where
                         local currency accumulations could help reduce inflationary pressures.
                         AID'S Africa Bureau has issued guidance calling for a more complete
                         examination of the macroeconomic implications of local currency
                         activity and for programming in the context of government monetary
                         policy.



                         Page 38                                      GAO/NSIAD-BO-21OBR   Foreign   Assistance
Appendix II

Comments From the Agency for
International Development


                                          AGENCY     FOR    INTERNATIONAL       DEVELOPMENT
                                                           WASWINOTON. D c 20123




                         ASSISTANT
                       AOMINl5TRATOR                                            4JG 3 iclfm



                  Mr. Frank C. Conahan
                  Assistant     Comptroller      General
                  National     Security    and
                    International       Affairs    Division
                  General Accounting        Office
                  Washington,     D. C. 20548
                  Dear Mr. Conahan:
                  The Agency for International       Development    (A.I.D.)      concurs with
                  the findings   and conclusions     in the GAO draft       report,    “Foreign
                  Assistance:    Use of Host Country-owned       Local Currencies.”           I
                  wollld  like to highlight    the four key conclusions         of the report.
                  1.     When the United States provides                commodities     or dollars      as
                         assistance     to recipient        countries,      the local currencies
                         that are generated         from this assistance           are owned by the
                         host country.       The currencies          are not an added resource           to
                         the host country       economy -- the added resource               comes with
                         the initial     U.S. assistance          provided     in the form of cash or
Now on p. 2              commodities.       (p. 3) This conclusion               is consistent     with
                         the existing     statutory       framework of the Foreign Assistance
                         Act of 1961, legislative            history     accompanying
                         appropriations      legislation,         and years of Agency practice
                         recognized     by Congress.
                  2.     In Tunisia       and Zaire [the two countries        in which the GAO
                         undertook      fieldwork],     local currencies     were programmed in
                         fiscal    year 1988 for uses generally          consistent   with U.S.
                         development        objectives    and were generally     used for the
Now on p. 2              agreed upon projects          and programs.     (p. 4) I believe     this
                         conclusion       also applies     to most countries     in which local
                         currency     is programmed.
                  3.     A.I.D.‘s     oversight   of local currency      use has not always
                         been adequate to reasonably         ensure that the currencies      were
                         consistently      used for the agreed upon purposes.        A.I.D.    is
                         considering      improved oversight     guidance that will   properly
                         focus on the responsibilities         and financial    management
Now on p, 2              capabilities      of the host government.        (p. 4) I am pleased
              Y




                                                                                                                            J


                             Page 39                                            GAO/NSIALk90-210BR   Foreign   Assistance
                                                                                                  ,



                     Appendix II
                     Comments From the Agency for
                     Inti3nationd Development




                                                      -2-
                     to report  that A.I.D. ‘6 Office    of Financial       Management has
                     nearly completed the preparation      of stronger,       clearer
                     Agency guidance that will     improve local      currency    oversight.
               4.    In most countries,      it is unlikely     that in 1988 generating
                     and spending local      currencies    associated   with U.S.
                     assistance   had a significant       macroeconomic    effect.     Also,
                     in most countries     accumulations     of unspent local      currencies
                     are not large enough to have a significant            future
Now on p. 2.         macroeconomic   effect.       (P. 4)
               The draft    report   represents     a comprehensive     and balanced
               assessment of the use of host country-owned              local   currencies.
               The analysis     is professional      and the presentation       of the
               results,   especially     the use of graphics,       makes the document        a
               readable and valuable        resource   for future    reference.
               I appreciate     the opportunity      to comment on the      report.

                                                            Sincerely,



                                                            BUteaU  fOK PKOgKam
                                                               and Policy Coordination


               cc:    IG/PPO,   John Eckman




                     Page 40
Apperidix III

Cixnments From the Department of Agricdture


supplementingthoseinthe
report text appear at the
end of this appendix.           UnltedStatea               Foreign                 Washlngton,D.C.
                                                           ;f$upral                20250




                                Mr. Frank C. Conahan
                                Assistant     Comptroller General
                                International    Affairs  Division
                                U.S. General Accounting Office
                                441 G Street,    N.W.
                                Washington, D.C. 20548

                                Dear Mr. Conahan:

                                This Is In response to your recent memorandum requesting   our revlew of draft
                                report NSIAD-90-210BR entltled  "Foreign Assistance:   Use of Host Country Owned
                                Local Currencies.“

                                We concur In your overall    conclusion   that AID Is responsible   for providing
                                assurance that host government owned local currencies       be programned for agreed
                                upon purposes.   The guidelines    proposed by AID's financial    management offfce in
                                April 1990 to address the weaknesses pointed out in this draft report,          which
                                include a requirement that host countries      using local currencies   submit formal
                                and standard financial    assessments and audits of host country agencies, should
                                improve AID's oversight    of host country programs.
                                More speclfically,       the Department   offers   the following     comments regarding     the
                                report:
Seecommentl.                    1.   References to Title   I, P.L. 480 "loans"         should be changed to "concessional
                                     credit"  wherever they appear.
Seecommentl.                    2.   References      to sectlon   416 should be changed to "416(b)".

Nowonp.14.                      3.   The second paragraph on page 22 should be revised to indicate        that trust
                                     accounts are uncommon in Title      I and section 416(b) programs.    This
                                     paragraph glves the impression that trust accounts for local currencies         are
                                     common. There Is only one P.L. 480 case of which we are aware where a trust
Seecommen;2.                         account was used.    In this case, the country did not have the sophistication
                                     to manage the currencies    generated.    There may be some confusion between
                                     trusts and special accounts.
                                Finally,  one area of your report which we would like to address concerns the
                                programming of host country owned local currencies    for AID mission general
                                operating  expenses and costs associated with supporting   development projects.

                            Y




                                       Page 41                                               GAO/NSL4D-9O-21OBR    ForeQn    Adstance
                                                                                                           ,
                                                                                                               r


                             Appendix III
                             Comments From the Department
                             of Agriculture




                     Mr. Frank C. Conahan                                                              2


                     Uhlle we appreciate     that using these currencies   in this manner may be
                     approprlate  in certain     instances,  we belleve the general Intent of the
See comment 2.       P.L. 480 legislation      Is to provide direct support for agreed upon development
                     programs and projects.

                     Thank you for the opportunity     to comment on this   draft.

                     Slncerely,




                     Administrator




                 Y




                             Page 42                                          GAO/NSIAIMO-210BR   Foreign      Assistance
                 Appendix KU
                 comments From the Department
                 of A@lculture




                 The following are GAO’S comments on the Department of Agriculture’s
                 letter dated August 3, 1990.


                 1. The wording in the text has been revised to incorporate this suggested
GAO Comments     change.

                 2. Local currencies held in trust by the missions and used for mission
                 administrative costs are primarily generated through ESF or DFA. Curren-
                 cies generated through Public Law 480 must be used for development
                 purposes, while a portion of currencies generated through ESF and DFA
               ’ may be used for other purposes such as administrative expenses.




                ’ Page 43                                 GAO/NSLAD-BO-21OBR   Foreilpl   AssMance
                                                                                                C

                                                                                                      ,
Appendix IV

Mqjor Contributors to This Briefing Report                                                                ’


                               Donald Patton, Assistant Director
Nationa1      Security   and   Kay E Brown Senior Evaluator
International Affairs                    ’
                               Bruce L. Kutnick, Senior Economist
                               Toni Y. Townes, Evaluator
Division,                      Maria Santos, Evaluator
Washington, D.C.




                               Page 44                              GAO/NSIAD&21OBR   Foreign       Assistance
Page 46   GAO/NtRAD@O-210BR   Foreign   Aseistance
Page 40   GAO/NSLAD-SOdlOBR   Foreign   Assistance
Page 47   GAO/NSIAD-BO-210BR   Foreign   Aseletance
Related GAO Products


              El Salvador: Accountability     for U.S. Military and Economic Aid         (GAO/
              NSIAD-90-132,   Sept.   1990)


              Using Local Currency Generated by U.S. Food Aid for Development Pur-
              poses (GAO/T-NSAID-90-32, April 18, 1990).

              Foreign Aid: Problems and Issues Affecting Assistance        (GAO/NSIAD-8%
              61~R, Dec. 30,1988).

              Foreign Aid: Better Management of Commodity Import Programs Could
              Improve Development Impact (GAO~NSIAD-88-209, Sept. 26,1988).

              Food Aid: Improving Economic and Market Development Impact in
              African Countries (GAOINSIAD-88-65, Dec. 21, 1987).

              Foreign Aid: Accountability and Control Over U.S. Assistance to Indo-
              nesia (GAOjNSIAD-87-187, Aug. 19, 1987).

              Liberia: Need to Improve Accountability     and Control Over U.S. Assis-
              tance (GAO~NSIAD-87-173, July 16, 1987).




(472195)      Page 48                                     GAO/NSLAD-90-210BR   Foreign   As&tame
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