The dollar exchange rate
The Netherlands buys the JSF and the related equipment directly from the US government and pays for its purchases in US dollars. In other words, any changes in the value of the US dollar relative to the euro affect both the cost estimates and the payments made for the JSF.
The dollar exchange rate used in the cost estimates
The Dutch Ministry of Defence uses what is known as a planning dollar exchange rate in its estimates of those items that need to be paid for in dollars. The planning dollar exchange rate is an exchange rate used purely for the purpose of the cost estimates. The amount actually paid in practice depends on the exchange rate on the date on which payment is made.
As the estimates must remain within the limits set in the financial framework, a high planning dollar exchange rate may cause certain problems. In 2016, for example, the planning dollar exchange rate was so high that the Ministry’s cost estimates for the JSF exceeded the maximum limit by almost €0.5 billion.
The dollar exchange rate used for payments
As we have pointed out, the payments made to the US are based not on the planning dollar exchange rate, but on the actual exchange rate pertaining on the date on which payment is made. For this reason, there is always a discrepancy between the amount quoted in the estimate (based on the planning dollar exchange rate) and the actual value of the payment. Obviously, the amounts paid in practice may also not exceed the maximum limit set in the financial framework. This means that the Ministry of Defence is exposed to a serious currency risk.
The government made clear in the policy document entitled In the Interests of the Netherlands that the contingency reserves included in the JSF budgets should not be used for hedging the currency risk. The only way in which the Minister of Defence can mitigate this risk is by using forward exchange contracts. Under a forward exchange contract or ‘currency swap’, dollars are bought at a specified date in the future, but at a preset exchange rate.
The Minister of Defence announced in the 19th progress report on the replacement of the F-35 published in September 2018 that she would henceforth also be using the contingency reserve as a hedge against the currency risk. Despite this move, the Ministry still needs to arrange currency swaps to protect itself against the currency risk.
Our own suggestions for better managing the currency risk
While currency swaps are indeed a means of reducing the vulnerability of defence projects to the risk of fluctuating exchange rates, their effectiveness is limited as the Ministry of Defence cannot enter into such contracts until the date on which a legal obligation is actually created. The creation of an obligation may of course have either a positive or a negative currency effect.
We described this aspect in our audit report entitled Lessons learned from the JSF project, in which we made a number of suggestions for improving the way in which the Lower House is informed about the currency risk.