As indicated in the Trump administration’s skinny budget released in March, the FY18 budget request incorporates the idea of transitioning the Foreign Military Financing (FMF) program from grants to loans. The stated intention is to “reduce costs for the US taxpayer, while potentially allowing recipients to purchase more American-made weaponry with US assistance, but on a repayable basis.” As with a consumer purchasing a new automobile, a loan is sometimes advantageous for the parties involved—but not always. And a transaction involving the US government incorporates additional elements. From a financial perspective, the end result could be good, bad, or very, very ugly.

Some historical context

This is not an entirely new practice. As noted by the State Department in a March release, the Obama administration concluded a $2.7 billion loan to Iraq for the purchase of US weapons. However, providing loans to sovereign governments, rather than grants, has been the exception rather than the norm. According to US Treasury Department data, the amount of outstanding Department of Defense loans has dropped from roughly $7.5 billion 20 years ago to around $350 million currently (not counting the $2.7 billion Iraq loan). The drop is due to a combination of old loans being repaid, a pause in new loans, and the write-off of a number of uncollectible loans (more on that below).

The good

While critics worry that loans will have a negative impact on sales, the basic concept of requiring countries to finance purchases, rather than receive grants that subsidize purchases, has some merit from a purely financial perspective. It would align the approach for supporting exports of military hardware with the practice applied by the US Export-Import Bank for nonmilitary goods. It is arguably a much more efficient use of US taxpayer resources: following US budget rules established under the 1990 Federal Credit Reform Act, appropriated funds would only need to cover the estimated long-term cost to the government of the loan, calculated on a risk adjusted net present value basis over the life of the loan (the methodology and process for calculating the subsidy cost was assessed in considerable detail by the Government Accountability Office in 2004). In the case of Iraq, only $250 million in appropriated funds was needed to finance $2.7 billion in purchases. For countries where the risk of default is low, the cost to the taxpayer from a budget standpoint could be lower for every dollar of hardware purchased, compared to grants. And if the loan is repaid in full and on time, there would be no net expenditure. In fact, as is the case with Ex-Im and the Overseas Private Investment Corporation, the program could return more to the US Treasury than was expended at the time of the purchase.

The bad

There is a frightening lack of transparency to the FMF sales program that leaves it vulnerable to corruption—a not-insignificant risk, as demonstrated by past activities in the Department of Defense procurement process. There does not seem to be a transparent, accountable process for determining the terms of the loans, much less how the grants are applied. Moreover, based on statements by OMB Director Mulvaney at the May 22 budget briefing, there does not seem to be an agreed methodology for determining which countries would continue to receive grants and which would receive loans. And finally, the fact that the US Treasury Department database on foreign credit exposure does not reflect the 2016 Iraq loan raises doubts that the lending program will be subject to the oversight and public financial management best practices that the United States encourages other governments to adopt.

The very ugly

As mentioned above, the United States has had to write off a considerable amount of debt over the years following debt treatments negotiated at the Paris Club. These debt reduction agreements cover a number of countries that have recently benefited from the FMF program, such as Liberia, Egypt, Pakistan, and Iraq. There is a considerable risk that US lending activity, if not well managed in accordance with recently endorsed G20 operational guidelines for sustainable financing, will push these countries toward the brink of another series of debt crises.

Members of the US Congress would be well advised to take a closer look at the FMF program as it transitions from grants to loans. Questions they may want to pose include:

Why should some countries that can afford loans be given grants, and others that struggle with debt sustainability be required to take loans?

Is there a transparent and accountable methodology for determining the terms of the loans?

Is the US government consulting with the IMF and World Bank on the terms of loans to developing countries?

Taking a transparent, disciplined approach to FMF loans can help mitigate the risk of needing to provide debt relief in future years, which would cost considerably more money for American taxpayers than would be saved in the early years of a lending program.