Educational, ultural Organization Executive Board

Transcription

1 ex Educational, ultural Organization Executive Board Hundred and thirtv-fifth Session 0 e 135 EX/21 PARIS, 25 July 1990 Original: English Item 7.'5 of the provisional agenda PROCEDURES FOR THE PROTECTION OF THE PURCHASING POWER OF THE REGULAR BUDGET FROM ADVERSE CURRENCY FLUCTUATION OF THE FRENCH FRANC SUMMARY At its twenty-fifth session, the General Conference adopted resolution 33.2 by which it requested the Executive Board to study further during procedures for the protection of the regular budget from adverse currency fluctuation of the French franc and to make proposals thereon to the General Conference at its twenty-sixth session. This document is submitted by the Director-General to assist the Board to formulate proposals on this question for the forthcoming session of the General Conference. Decision required: paragraph 23.

2 135 EX/21 INTRODUCTION 1. The Executive Board at its 127th session in autumn 1987, considered a study by the Director-General on various measures that might be taken to protect the purchasing power of the budget of Unesco, assessed solely in US dollars at that time, in view, of its exposure to adverse currency fluctuation of the French franc, its principal currency of expenditure. Having considered this report, the Executive Board decided (127 EX/Decision 8.9) to recommend to the General Conference the selection of either a split-level assessment system or a forward purchasing system for the financial period, on the understanding that no additional costs would arise for Member States or additional reserves be established. 2. In the intervening period between the 127th session of the Board and the meetings of the Administrative Commission that took place during the twenty-fourth session of the General Conference, the market conditions for forward- purchases of French francs against dollars deteriorated considerably. As a result it became impossible in October/November 1987 to enter into contracts for forward purchases of French francs, at a rate of exchange more favourable than the proposed budget rate of FF 6.04 to the dollar. Following the advice of a Working Group of the Administrative Commission, the General Conference decided to adopt (24 C/Resolution 35.3) the split-level system for assessment of contributions in two currencies (US dollars and French francs) for Subsequently, a Working Group of the Special Committee of the Executive Board, established to carry out a comprehensive review of the Financial Regulations and the Budgeting Techniques of the Organization, considered the question of currency fluctuation during In its report contained in document 130 EX/SP/4 the Working Group agreed that it was premature to reach any conclusions at that stage, pending the completion of the Joint Inspection Unit report on Budgeting in Organizations of the United Nations System: Some Comparisons, and also the results of a further study by the Secretariat of long-term solutions to problems posed by currency fluctuation on the Organization s budget. 4. The report of the Joint Inspection Unit (JIU/REP/89/9) was issued in June Recommendation 8 of that report reads as follows: With a view to minimizing the adverse effects of currency fluctuation, the organizations concerned should envisage that: (a> organizations which spent over 85 per cent of their expenditure in local currency at headquarters should switch their budget currency to this local currency; and (b) all other organizations should examine the possibility of introducing a split-assessment system in the two main currencies of their regular budget expenditure or, where appropriate, a forward purchasing of estimated currency needs.

3 135 EX/21 - page 2 Unesco spends roughly 60 per cent of its regular budget in French francs and therefore falls into category (b) of the JIU s recommendation. Since the Director-General agrees with this recommendation, he submitted document 25 C/50 Add. to the General Conference in October 1989, in which he drew the attention of the Conference to an attractive opportunity then existing for forward purchasing of the French franc requirements of the Organization for the following biennium. 5. As had been the case in October/November 1987, the market rate of exchange of the US dollar against the French franc experienced a downward trend during October/November Consequently, it would not have been possible to enter into forward purchasing contracts during the Conference, without revision of the rate of FF 6.40 (October 1989 operational rate of exchange) proposed for calculation of the currency adjustment under Part VIII of the budget for in document 25 C/5 Rev. 2. The General Conference considered it would be best to continue with the split-level assessment system it had approved for for a further biennial period. Nevertheless, by resolution 33.2 the Conference requested the Executive Board to study further during procedures for the protection of the regular budget from adverse currency fluctuation of the French franc, notably the advantages and disadvantages of a split-level assessment system compared to a forward purchasing system; the study should take into account all of the budgeting techniques of the Organization, with particular reference to the rate of exchange of the French franc used to calculate the budget and the amount provided in Part VIII of the budget for currency adjustment; proposals thereon should be made by the Executive Board to the General Conference at its twenty-sixth session. BUDGETING TECHNIQUES 6. The budgeting techniques applied in the preparation of Unesco s budget include recasting of the budget base for inflation and use of a constant rate of exchange between the dollar and the French franc. Special provision is made for anticipated cost increases over the financial period covered by each budget. Thus the purchasing power of the budget from one biennium to the next can be maintained, if the problem of currency fluctuation can be neutralized. For this purpose it is necessary to develop a system to ensure the Director-General will have available for regular budget expenditure in the biennium concerned the estimated requirements in US dollars and in addition the estimated requirements in French francs, to avoid exposure to deficit should the French franc rate of exchange to the dollar appreciate on average during the biennium above the rate used to calculate the budget. 7. The following table shows the budget and assessment level for calculated at the constant dollar rate (without currency adjustment), the operational rate for November 1989 (FF 6.25), the operational rate for January 1990 (FF 5.72), and the actual approved budget rate of FF 6.40, which was the operational rate of October Part VIII of the budget shows the currency adjustment arising from the different rates of exchange used to convert estimated French franc requirements for the biennium into dollars at the budget rate of exchange compared with the constant rate of FF 6.45 to US $1. In each case the estimated miscellaneous income is deducted in order to reach the amounts to be assessed on Member States in dollars:

4 135 EX/21 - page 3 Budget at FF 6.45 Budget at FF 6.40 Budget at Budget at FF 6.25 FF 5.72 $ $ $ $ Parts I - VII Part VII - Currency adjustment 377,021,OOO 377,021,OOO 1,767,OOO 377,021,OOO 377,021,OOO 7,238,517 28,869,504 Total budget 377,021,OOO 378,788,OOO 384,259, ,890,504 Less: Miscellaneous income 13,935,ooo 13,935,ooo 13,935,ooo 13,935,ooo To be assessed 363,086,OOO --_ ,853,OOO ,324, ,955, _ _ SPLIT-LEVEL ASSESSMENT SYSTEM 8. The split-level assessment system is designed to ensure that when all contributions are paid, the Organization will receive the estimated fixed amounts it needs both in US dollars and French francs. The following tables show the amounts that would be assessed under the split-level system if the rate of exchange had been fixed at FF 6.45, FF 6.25, or FF 5.72 compared with FF 6.40 actually approved. In each case the formula applied is as approved at the twenty-fifth session of the General Conference, whereby the total of contributions to be assessed in each currency is determined as follows: (i> in French francs - 60 per cent of the total of Parts I to VII of the budget calculated at the rate of US $1 equal to FF 6.45; (ii) in US dollars - the remainder of the amount of contributions of Member States to be assessed in accordance with Part A, subparagraph (h), of the Appropriation Resolution for after deduction of the equivalent in US dollars of the French franc amount determined under (i) above, translated at the approved budget rate of exchange for the French franc. The calculation of the total to be assessed in US dollars is as follows: Budget Budget Budget Budget exchange rate exchange rate exchange rate exchange rate FF 6.45 FF 6.40 FF 6.25 FF 5.72 $ $ $ -$ Total to be assessed (see para. 7 above) 363,086,OOO 364,853,OOO 370,324, ,955,504 Less: French franc portion of budget [calculated in accordance with subparagraphs (i) and (ii) above] 226,212, ,979, ,451, ,082,390 To be assessed in dollars 136,873, ,873, ,873, ,873, =========== _ _

5 135 EX/21 - page 4 The preceding table shows that irrespective of the rate of exchange of the French franc chosen for calculating the currency adjustment under Part VIII and consequently the overall budget, the use of the split-level system results in the assessment of US $136,873,114 to which would be added the following amount in French francs in the three cases illustrated: French franc portion of budget Budget rate French franc portion after conversion into francs $ FF. 226,212, ,459,071, ,979, ,459,071, ,451, ,459,071, ,082, ,459,071,270 Thus the system ensures that the Organization should have at its disposal the estimated amount of dollars required - US $136,873,114, as well as the estimated amount of French francs required - FF 1,459,071,270. In this way constant purchasing power is approximated irrespective of exchange rate fluctuation between the US dollar and the French franc. 9. It is demonstrated from the foregoing illustration of the split-level assessment mechanism in action, that whatever the rate of exchange chosen to calculate the budget for , the amounts assessed on Member States in US dollars and in French francs would have remained the same. It follows that a change in the budget rate of exchange during future sessions of the General Conference, would not increase the number of US dollars and French francs to be assessed, if the split-level system is applied. Whether Member States had chosen the rate of FF 6.45, FF 6.40, FF 6.25 or FF 5.72 for the calculation of Part VIII of the budget, they would still have been assessed US $136,873,114 plus FF 1,459,071,270 for Therefore the adjustment of the budget rate of exchange to the market rate of exchange during a General Conference would not involve additional cost for Member States since the total amount of the French franc contributions of Member States, when expressed in US dollars, increases or decreases in accordance with fluctuation of market rates of exchange. However, Member States might wish to adjust the budget rate of exchange, in order to take advantage of any attractive opportunity that may exist on the market in future, for the forward purchasing of French francs in the quantities required for the regular budget of the following biennium, while the General Conference is still in session. As will be shown in the following section of this study, such a change would entail no additional liability for Member States and in certain market conditions could yield substantial miscellaneous income to be deducted from contributions. FORWARD PURCHASING 10. Forward purchasing is widely used in the public and private sectors, for international trading in goods and services as well as in capital markets, to ensure that income that will arise in one currency at a future time may purchase a given amount in a second currency at that same future time. Contracts can be arranged through most major international banks, whereby fixed amounts in French francs can be purchased at pre-determined future dates in exchange for fixed amounts in US dollars, The market in such contracts, known as currency swaps, is estimated to have exceeded $150 billion for all currencies in 1989.

6 135 EX/21 - page Forward purchasing is not speculative. Its objectives are exactly the opposite, namely to provide protection from exposure to unforeseeable exchange rate fluctuation in this era of floating exchange rates for a wide variety of users. Contracts are agreed on the basis of the spot rate of exchange on the market on the day of the transaction. Future payment is calculated to include a premium or discount compared with spot rate of exchange, because of potential interest rate income differentials between the two currencies. If one is buying French francs forward against dollars, a premium over the spot rate can be. obtained if French franc interest rates are higher than dollar interest rates. This was the case in October/November 1989 during the twenty-fifth session of, the General Conference. Quotations were obtained from three reputable banks for forward currency contracts covering the period January 1990 to December These quotations showed that an average premium of 7 centimes to each dollar could have been obtained on 12 October In other words, the Organization could have entered into forward contracts at a profit of at least $2.4 million, which could have been used to reduce contributions. 12. The procedure envisaged at the time was to enter into 24 individual contracts of about $9.3 million each (total French franc requirements were estimated to be the equivalent of $222.5 million for ) while the General Conference was in session. These contracts would have matured for settlement in each month of the following biennium. The dollar consideration of $9.3 million each month would only have been paid at the various dates in those future months, on receipt of the corresponding amounts of French francs agreed in the contracts. Thus, it was foreseen that the total commitment could have been accommodated within the normal cash flow foreseen for the Organization in the biennium. 13. If the Executive Board wishes to recommend this potentially attractive alternative to the split-level system, some revisions would be required to resolutions submitted to the General Conference notably the Appropriation Resolution and the proposed resolution on currency of payment of contributions. The adoption of a forward purchasing system would not necessarily change the Part VIII system of recording budget expenditure in French f rants, or any of the other budgetary techniques approved for PRACTICES IN OTHER ORGANIZATIONS OF THE UNITED NATIONS SYSTEM 14. Both UNIDO and IAEA use a split-level assessment system whereby contributions are assessed partly in dollars and partly in Austrian schillings. These Organizations are generally satisfied with the results obtained and have decided to continue with the system for their current financial periods. 15. FA0 and IL0 have both utilized forward purchasing systems to protect the purchasing power of their budgets from adverse currency fluctuation. FA0 was able to purchase Italian lire at a profit to cover part of its regular budget requirements for because lira interest rates were higher than dollar interest rates. For , however, FA0 has not made forward purchases of lire because the lira/dollar rate of exchange fixed by the last session of the FA0 Conference has remained unfavourable for such an operation up to the date of preparation of this document. On the other hand, in IL0 because Swiss franc interest rates have been historically lower than dollar interest rates, that Organization decided for to assess regular budget contributions entirely in Swiss francs and to buy forward its dollar requirements for the current biennium at a profit.

7 135 EX/21 - page All organizations in the United Nations system with assessed budgets, where 85 per cent or more of expenditure is incurred in local currency at headquarters have switched their budgets and currency of assessment to that local currency. The other organizations with assessed budgets (United Nations, WHO and ICAO) continue to assess contributions solely in US dollars without forward purchasing. The United Nations and WHO have substantial expenditure requirements in several currency zones and therefore would not find adequate protection in a two-currency assessment system; consequently these two organizations have developed other technique? to meet currency fluctuation problems. ADVANTAGES AND DISADVANTAGES OF THE TWO SYSTEMS 17. From the foregoing analysis of practices in the United Nations system, it may be seen that different procedures have been developed from organization to organization to protect assessed budgets from currency fluctuation in accordance with their individual requirements. For Unesco the recommended choice of a system to protect the purchasing power of its budget would be either the existing split-level procedure or a forward purchasing procedure. 18. The budget in Unesco was the first to be voted with a split-level assessment system. The experience of that biennium, however, brought no immediate benefit, since the regular budget purchasing power in would not have suffered under the pre-existing dollar assessment system because the average rate of exchange of the dollar to the French franc of FF 6.11 did not vary significantly from the rate of FF 6.04 used to calculate tile budget for On the other hand, the experience gained during in managing the system without fundamental redesign of the existing computerized budget and general accounting programmes will be of great benefit for the future. For example, the budget of will be protected to a very large extent from any protracted fall in the exchange rate of the dollar to the French franc below the budget rate of FF 6.40, such as has been experienced from the commencement of the current biennium. 19. The advantage of forward purchasing would be the elimination of the complexity of the dual currency assessment and contribution accounting mechanisms required under the split-level system. Contributions would be assessed solely in US dollars. The exchange rate risk that the French franc might appreciate against the dollar, between the date of approval of the budget at the General Conference and the date when contributions become due (as happened between October 1989 when the rate was FF 6.40 and January 1990 when the rate was FF 5.72) would no longer be exported to Member States. Moreover, the administration of the split-level system is very time-consuming, estimated at more than double the work of a forward purchasing system for the Secretariat. Many Member States experience difficulties with the methodology of the split-level system, which gives rise to frequent contestation and inquiries regarding figures and calculations. 20. Whatever system is recommended by the Board and decided by the General Conference for future biennia, the budget requirements of an international organization such as Unesco will no doubt continue to be for one unified programme budget. This budget is expected to continue to have many flexible features regarding subprogrammes, modalities of execution, decentralization, international procurement, etc., without subdivided limitations with regard to expected income in dollars and in French francs. Consequently limited residual exchange fluctuation exposure will remain, principally due to the following:

8 135 EX/21 - page 7 (i> under both systems if the actual percentage of expenditure in French francs is different from the estimated percentage used for the calculation of the French franc amount required for the assessment of Member States contributions; (ii) under the split-level system if contribution payments have to be converted from one currency to the other currency of assessment on the <market, when contributions are not received in both currencies simultaneously in full and when operational rates of exchange differ from market rates; (iii) under the forward purchasing system if the monthly French franc expenditure pattern is different from that anticipated and reflected in forward purchase contracts. Su ch limited exchange variations could be added to or deducted from the estimate of Miscellaneous Income for the next available future biennium, in accordance with the technique already approved for the budgets of and CONCLUSION 21. In the light of the information given in this document, the Executive Board may wish to make appropriate proposals on the subject to the forthcoming session of the General Conference. The conditions under which forward purchases of French francs could be made during the twenty-sixth session of the General Conference are as follows: if interest rate differentials are such that the French franc requirements of the Organization for could be purchased through forward contracts at a profit, advantage could be taken of this possibility; in the event of such a proposal, the Executive Board could further recommend that the budget rate of exchange be adjusted as necessary from the operational rate for the month of October 1991 to the actual average rate of exchange obtainable on forward currency contracts for while the Conference is in session; the profit on the exchange rate contracts would be deducted in this way from Member States contributions; to avoid the disruption of change for all concerned, however, the switch to a forward purchasing system should reasonably be for a trial period of four years; this would involve a commitment to forward purchases again for irrespective of market conditions in October/November 1993; the results obtained from the forward purchasing system for would be reviewed by the Executive Board at its autumn session in 1994 to determine its longer term acceptability, since changing from one system to another in successive financial periods would be disruptive for budget planning within governments of Member States. This suggestion is made because of the experience of , because only in the second or third year of operation of the split-level system did many contributors began making payments of contributions in both currencies of assessment. 22. On the other hand, now that the Member States and the Secretariat have adapted to the split-level system which is expected to give the necessary

9 135 EX/21 - page 8 protection to budget purchasing power, the Board may wish to recommend that the split-level assessment system be continued for an indefinite period. In this event the Director-General should be invited to propose an appropriate amendment to Article 5.6 of the Financial Regulations to underline the prospective long-term continuation of the system thereafter. DRAFT DECISION 23. The draft decision that follows provides-the texts of alternative options under heading A or B, one of which the Board may wish to recommend to the General Conference, in the light of the foregoing study: The Executive Board, 1. Having examined the report of the Director-General on procedures that could be followed for the protection of the purchasing power of the regular budget of the Organization from adverse currency fluctuation of the French franc, prepared in accordance with resolution 33.2 adopted by the General Conference at its twenty-fifth session, 2. Recommends to the General Conference that: A (i) if market conditions are such that the Director-General could * enter into contracts for the forward purchase of the French f rant requirements of the Organization for the biennium at a saving compared with the theoretical purchase of an equivalent amount of French francs at the spot market rate of exchange, the General Conference could authorize such action on the understanding that the budget rate of exchange would be adjusted to the average rate of exchange obtained in the forward purchase contracts and that the budget would be recalculated accordingly; (ii) if market conditions are such that forward purchases of French francs would not yield savings compared with a budget calculated at the spot rate of exchange of the French franc prevailing during the General Conference, the split-level assessment system for the determination of contributions of Member States partly in US dollars and partly in French francs, in accordance with estimated requirements for the biennium, should be continued for an indefinite period and Article 5.6 of the Financial Regulations should be modified to read as follows: Contributions to the budget and advances to the Working Capital Fund shall be assessed and paid in a currency or currencies to be determined by the General Conference ;

10 135 EX/21 - page 9 B 2. Recommends to the General Conference that the split-level assessment system for the determination of contributions of Member States partly in US dollars and partly in French francs, in accordance with estimated requirements for the biennium, should be continued for an indefintte period and Article 5.6 of the Financial Regulations should be modified to read as follows: Contributions to the budget and advances to the Working Capital Fund shall be assessed and paid in a currency or currencies to be determined by the General Conference.