House of Commons - FCO Performance and Finances

FCO Performance and Finances - Foreign Affairs Committee Contents

2 The effect of the Spending Review on the performance of the FCO

The FCO's budget

7. Compared to those of other departments, the FCO's budget is distinctive in three respects. First, it is small. The FCO Departmental Expenditure Limit (DEL) resource budget of £2.35 billion represented 0.65% of all government departments' combined resource DEL spending in 2009-10. The Foreign Secretary, Rt Hon William Hague MP, told us in September 2010 that "the entire spending of the Foreign Office, including the World Service, the British Council, international subscriptions and everything else, is less than the spending of Kent County Council".[6] By comparison, the Department for International Development (DFID) took 1.65% of the total, and the Ministry of Defence (MOD) 8.62% in 2009-10. By 2014-15 it is expected that the FCO's share will fall to 0.36%, while DFID's share will increase to 2.86%. This is illustrated in the table below.[7] Resource and Capital DEL budgets as a percentage of total Government DEL, 2009-10 and 2014-15

Resource DEL (excl. Depreciation) Capital DEL

2009-10 2014-15 2009-10 2014-15

FCO 0.65% 0.36% 0.35% 0.25%

MOD 8.62% 7.51% 16.25% 21.64%

DFID 1.65% 2.86% 2.30% 4.98%

8. Secondly, a large proportion of the FCO's spending is relatively inflexible, because it is committed to staff salaries and buildings, rather than programmes. The FCO is also primarily responsible for paying the UK's subscriptions and other dues to international organisations such as the United Nations, which are typically determined according to a set formula.[8] Before the General Election the then Foreign Secretary, Rt Hon David Miliband MP, estimated that in 2009-10, the total 'discretionary' spending, i.e. excluding international subscriptions, peacekeeping and conflict-related spending, and the ring-fenced funding for the British Council and BBC World Service, was around £830 million, which represented 39% of the FCO's total budget.[9]

9. Thirdly, over half the FCO's budget is spent in currencies other than Sterling.[10] This is the highest proportion in Whitehall. As a result, the FCO's budget has been particularly vulnerable to exchange-rate fluctuations.

Pressures on the budget

10. Even before the current round of spending cuts, the FCO's budget has come under considerable pressure in recent years. In 2009-10, the Department was obliged to take steps which the then Permanent Under-Secretary, Sir Peter Ricketts, described as "pretty drastic", in order to remain within budget for the year. The measures involved short-time working and unpaid leave for local staff, and cuts to programme spending (including on counter-terrorism), health and safety, training, travel and hospitality.[11] Sir Peter told our predecessor Committee that if they continued, such cuts would affect the FCO's effectiveness.[12] In February 2010, the Treasury agreed to make up to an extra £50 million in budget relief available to the FCO for 2009-10, and allowed the Department to keep extra funds from asset sales; funds were also transferred to the FCO from the British Council and BBC World Service budgets, which previously had been ring-fenced once set for any year.[13]The FCO ultimately brought its total 2009-10 spend in at £2.35 billion, £22 million below budget (in 2008-09, total FCO spend was £2.12 billion).[14]

11. The pressure on the FCO's budget has arisen from:

Increased demands—primarily to increase the UK presence in locations which are dangerous and thus expensive in which to operate, such as Kabul; and to enhance the physical security of UK Posts overseas following the fatal attack on the British Consulate in Istanbul in 2003.
Rising UK subscriptions and other obligatory dues to international organisations, which are paid almost entirely from the FCO budget (£136.2 million in 2007-08, £145.5 million in 2008-09 and £177.4 million in 2009-10).[15]
The impact of the fall of Sterling, given the withdrawal of the Overseas Price Mechanism (OPM) as part of the last (2007) spending review. Under the OPM, the Treasury protected the FCO's local-currency purchasing power from the effects of exchange-rate fluctuations. The FCO spends over 50% of its budget in non-Sterling currencies. In its last Report on the FCO Departmental Annual Report, in March 2010, the previous FAC concluded that the FCO had lost around 13% of the purchasing power of its core 2009-10 budget as a result of the fall of Sterling;[16] the FCO puts its loss in 2009-10 as a result of Sterling weakness at £142 million.[17]
Savings already implemented as part of the previous Government's efficiency programme: including the British Council and BBC World Service, the FCO was required to find a cumulative £164 million in savings over the 2007-08 - 2010-11 CSR07 period (an original target of £144 million, plus a further £20 million added in 2009-10). By the end of 2009-10, the FCO had delivered £148 million and was forecasting a total by the end of 2010-11 of £187 million.[18] The FCO exceeded its target for efficiency savings in 2009-10 by £12 million.[19]

12. The 2004 and 2007 spending rounds resulted in a "flat or less than flat" real terms budget for the FCO.[20] This contrasted with the increases enjoyed by some other departments and agencies. For example, the average real-term reduction in the FCO's budget under the CSR07, of 0.2% a year, contrasted with an average real increase for other departments of 2.1%.[21]

13. Giving oral evidence to us on 8 September 2010, the present Foreign Secretary (Rt Hon William Hague MP) said that as a result of these increased pressures, the FCO's discretionary spending had been cut by 17% in two years.[22]

14. The scale of the earlier cutbacks implemented by the FCO gained widespread attention in January 2010, when then FCO Minister Baroness Kinnock told the House of Lords that FCO budget constraints had led to "staff redundancies, cuts to travel and training, and reduced programme funding including our work on counter-terrorism and climate change". Baroness Kinnock went on to say that:

We have had staff redundancies in Argentina, Japan and across the United States. Counter-narcotics programmes in Afghanistan, capacity building to help conflict prevention in Africa, and counterterrorism and counter-radicalisation in Pakistan have all been cut; the list goes on.[23]

15. In its March 2010 Report on the FCO's 2008-09 Annual Report, our predecessor Committee concluded that some of the cuts which the FCO was making were "unacceptably disrupting and curtailing" the Department's work, and represented a threat to its effectiveness.[24] Our predecessors drew attention to the consistent trend over the previous two spending rounds for the FCO to lose out relative to other departments and agencies in the allocation of government spending. For instance, in real terms the FCO's Total Departmental Spending excluding conflict prevention (in Sterling terms) was expected to be around 3% above the 2004-05 baseline in 2009-10 and 0% above the same baseline in 2010-11, whereas the figures for DFID, for example, were around 50% and 70% higher, respectively.[25]

16. Following the General Election, the Coalition Government passed its Emergency Budget in June 2010. The FCO subsequently announced that it would make a further £55 million in-year savings in 2010-11. At the time this represented 2.5% of the FCO's budget. £18 million worth of these savings were announced by the Foreign Secretary at the end of June 2010. These included:

Cutting spending on the FCO's "low-carbon growth" programme by around £3 million;
Cutting programme spending on drugs and crime by £1 million;
Cutting public diplomacy programmes by £1.6 million;
Reducing funding for scholarships by £10 million;
Reducing by 10% (£630,000) the Department's spending in support of the overseas territories;
Reducing by 10% (£300,000) spending in support of counter-proliferation; and
Reducing by 10% (£1.3 million) spending on the FCO's programmes on human rights and democracy (including the Westminster Foundation for Democracy).[26]

In its Main Estimate 2010-11 Memorandum, the Department stated that it still did not know precisely where the remaining £37 million of savings could be found, but suggested that it might involve the cancellation of spending on items such as advertising, consultancy, procurement and capital items, asset sales, and cuts to spending on the British Council and the BBC World Service.[27]

Key features of the Spending Review settlement

17. On 20 October 2010, the Chancellor of the Exchequer announced the outcome of the Spending Review (SR2010) which set departmental spending limits for the expected remainder of the Parliament. On the same day, the Foreign Secretary announced that the Foreign Office would see a 24% real terms reduction in the resource budget, and a 55% real terms reduction in capital spending over the four-year Spending Review period. The Department's administration budget would be reduced by 33%. However, he added that once the additional resources from the BBC were taken into account, the rest of the FCO budget would only fall by 10% over the Spending Review period.[28] The Daily Telegraph reported that the FCO had suffered some of the "biggest cuts" of any department in the Spending Review.[29] Meanwhile, the MOD faces a 7.5% cut while DFID's resource budget will increase by 37%.[30]

18. The table below analyses the SR2010 settlement for core FCO funding, when funding for the BBC World Service and the British Council has been removed from the calculation.Resource DEL budgets for FCO, 2010-11 to 2014-15

Total FCO Budget

£m
Combined British Council & BBC WS budgets

£m
Net FCO Budget

£m
Net FCO Budget in 2010-11 prices

£m
Percentage change for FCO compared to 2010-11 baseline

2010-11 1391 410 981 981

2011-12 1497 404 1093 1072 +9%

2012-13 1461 391 1070 1026 +5%

2013-14 1427 379 1048 979 0%

2014-15 1165 149 1016 925 -6%

19. Writing to us immediately following the Spending Review announcement on 21 October, the Foreign Secretary described the SR2010 settlement as a "good" settlement for the FCO "in the circumstances", but also described it as a "tough" settlement".[31] The Permanent Under Secretary of State at the FCO, Simon Fraser, later wrote to us, on 12 November, to highlight key elements of the settlement for the Department:

For the core FCO it is a 10% real cut over the four-year SR period, with a 33% administration cut target;
The creation of a new Foreign Currency Mechanism, which will restore some protection to FCO purchasing power overseas following the abolition of the Overseas Price Movements mechanism in 2007;
The peacekeeping budget has moved off the FCO baseline;
The contribution of the 'FCO family'[32] to UK Overseas Development Assistance (ODA) spending has increased to £273 million per year;
The Capital budget for the FCO family will reduce by around half immediately, with provision for recycling some asset disposal receipts; and
BBC World Service funding will be transferred from the FCO to the Licence Fee from financial year 2014-15.[33]Over the four-year Spending Review period, the World Service will suffer a real cut, allowing for inflation, of 16%, and the British Council of around 25%.

20. The Foreign Secretary welcomed the fact that the Spending Review settlement had resulted in greater "budget certainty" as a result of the introduction of a new Foreign Currency Mechanism (FCM), and stated that the settlement enabled the FCO to maintain the global reach of the UK's diplomatic network. However, at the same time, he cautioned that while the FCO would not need to undertake "drastic urgent restructuring", it would need to make "real choices" about what it did, to reduce the overall size of the workforce, to streamline structures and working methods, and to pursue rigorous efficiencies and better value for money.[34]

21. Giving oral evidence on 24 November, Simon Fraser provided us with more information on the exact breakdown of the financial settlement. He repeated that "the settlement is flat cash over the four-year period. We will get the same in cash terms over the four year period as we have now [...] That flat cash translates to about a 10% real cut over the four-year period." When we asked Mr Fraser to explain the apparent discrepancy between the figure of a 6% cut to the net FCO budget over four years set out in our table above and the equivalent figure of 10% put forward by his Department, he responded that, "24% is the figure for the overall cut for the FCO family [...] The 24% figure was the figure the Chancellor himself used on the day", while "the figure of 10% is the real cut at the end of four years for the FCO family which will then be the FCO and the British Council".[35]

22. Mr Fraser subsequently supplied further comments on this issue in writing. In a letter dated 13 December 2010, he stated that the FCO would move from a core resources budget in the present financial year of £981 million to a core budget in 2014-15 of £1,016 million, and he accepted that this was "a mathematical real terms cut of around 6%".[36] However, he added that:

these figures give only part of the picture [...] within them there is an amount of ring-fenced HMT money to fund the costs of the UK's International Organisations membership subscriptions and a cost sharing agreement for additional costs. When this formula, and the best forecast of costs in the final year, are taken into account the predicted core FCO cut is a shade under 10%.[37]

23. Mr Fraser elaborated on why there were differences between the scale of the cuts to the core FCO budget and to the budgets of the British Council and BBC World Service. He told us that this had been a decision by the Foreign Secretary "designed to ensure long-term proportionality and fairness across the whole FCO family". In particular, he wrote that Mr Hague had taken into account the following factors:

The British Council, and to a lesser extent, the World Service can supplement the FCO's Grant-in-Aid with commercial activities, while the FCO cannot;
The FCO is the 'lead department' on the UK's global presence—the British Council and World Service depend on it in the first instance;
The FCO has borne the brunt of previous funding reductions, particularly with regards to reduced capital spending and consequences of the removal of the Overseas Pricing Mechanism; and
The FCO core budget in previous years has declined as a proportion of the overall FCO family budget as a result of ring-fencing of the World Service and British Council budgets.

24. We conclude that the FCO is one of the major departmental losers in the Spending Review, certainly compared to the MOD and DFID, although we note that the 'core FCO' function has to some degree been shielded from the full ferocity of the cuts falling on the overall 'FCO family' budget, with a greater share of the pain being borne by the other 'family' members, the British Council and the BBC World Service. While it is not realistic to suppose that the FCO can be insulated from the need to scale back its spending and activities, in the context of the spending cuts being imposed across the entire public sector, we have particular concerns about its Spending Review settlement.

25. We conclude that reductions in spending on the FCO, if they result in shortfalls in skilled personnel and technical support in key countries and regions, can have a serious effect in terms of the UK's relations with other countries, out of all proportion to the amounts of money involved, especially in relation to the UK's security and that of its Overseas Territories. It follows that cuts to the core FCO budget even of 10% may have a very damaging effect on the Department's ability to promote UK interests overseas, given that these will come on top of previous cuts to the FCO's budget in the very recent past, which our predecessor Committee described, as recently as March 2010, as "unacceptably disrupting and curtailing" the Department's work and representing a threat to its effectiveness. We further conclude that the Spending Review settlement will accentuate the regrettable long-term trend for the FCO to lose out relative to other departments and agencies in the allocation of government spending.

26. We conclude that the 25% and 16% real-terms cuts to the budgets of the British Council and BBC World Service respectively will pose severe challenges to those two organisations. We note the FCO's arguments for redressing the balance of spending between the core FCO and the rest of the FCO family, in favour of the former, but we share the concerns that are likely to be felt in both the British Council and the World Service about the implications of the decision. We will examine those implications in respect of the British Council in more detail later in this Report. As we mentioned in paragraph 6 above, we propose to conduct a further inquiry into the implications of the Spending Review for the World Service, in the light of the cuts to its operations announced on 26 January 2011, and will issue a separate Report on this matter in due course.

Managing the settlement

27. In a press notice published on 21 October, the FCO indicated that it would aim to manage the reductions in expenditure identified in the Spending Review by:

Continuing to simplify, standardise and streamline support and corporate functions to reduce the burden on front line activities, through increased outsourcing, an increase in tasks carried out by local staff and a consolidation of financial, human resources, procurement and other activities regionally or within the UK;
As part of its current Workforce Strategy, continuing to reduce the overall size of the workforce by a reduction of UK based headcount of 10% over five years;
Reducing the cost of the Overseas Estate and looking for opportunities to reduce the estate in London, including looking to co-locate and rationalise the Government's different operations overseas;
Looking for savings through improved procurement practice including, where appropriate, co-procuring with other departments and greater use of central framework contracts; and
Reviewing the FCO's global and programme expenditure to ensure it is in line with the Foreign Secretary's three priorities of safeguarding Britain's national security, building Britain's prosperity and supporting British nationals around the world. We understand that this includes undertaking a zero-based review of the FCO's global network.[38]

28. In his memorandum to the Committee, Simon Fraser said that the FCO would take the opportunity to "reshape the organisation." He continued:

we do not intend simply to replicate past spending patterns, but to make some clear choices: this will mean achieving further savings, continue to reduce its headcount and streamline its structures. The FCO Board intends to reach agreement on allocations for the FCO as a whole by December, so that we can allocate resources to our Directorates and Posts, including our programme allocations, early in 2011, and finalise business plans well before 1 April (the start of the SR10 period).[39]

Reductions in the capital budget

29. The table below shows that in real terms the FCO's Capital budget will halve in real terms over the Spending Review period.Capital DEL budgets for FCO, 2010-11 to 2014-15

Total FCO Budget

£m
Combined British Council & BBC WS budgets

£m
Net FCO Budget

£m
Net FCO Budget in 2010-11 prices

£m
Percentage change for FCO compared to 2010-11 baseline

2010-11 200 32 168 168

2011-12 107 29 78 77 -54%

2012-13 102 22 80 77 -54%

2013-14 102 21 81 76 -55%

2014-15 98 5 93 85 -50%

30. We asked the FCO what impact reductions on this scale are likely to have, and what plans would be curtailed as a result. James Bevan, Director General Change and Delivery, told us that the settlement granted the FCO "an average of about £100 million capital every year." He said that this was "a significant drop [and] ... the bottom line is that it will be a tight four years in terms of capital allocation". Mr Bevan said that "I think there are going to be quite a lot of buildings that we would have wanted to build or acquire, but which we will not".[40] However, he was keen to highlight that capital gained through "recycled assets" (i.e. money raised from selling buildings) could be kept by the FCO under agreement with the Treasury. He suggested that this would also contribute around £50 million per year to the Department's capital budget, although he conceded that this would be an "ambitious" target.[41]

31. Despite the anticipated increased budget from recycled assets, the FCO's capital budget remains "tight". Much of the FCO's capital allocation is spent on overseas security: "constructing or protecting the buildings in which staff operate, the vehicles in which they travel, or other hardware to protect staff from the high terrorist threat that many face daily".[42] We queried whether the reduction in planned capital spending would lead to the security of buildings and staff being compromised. We were assured by Mr Bevan that this would not be the case and that the FCO's "top priority in allocating not only capital, but other resources, will always be the safety and security of our staff [...] If we were to conclude that we could not adequately protect the safety and security of staff [...] we would recommend that we withdrew those people." He stressed that priority would be given to capital investment in areas "where we need to protect our staff" and named Sana'a in Yemen and Jakarta in Indonesia as particular areas where security upgrades were needed. Overall, Mr Bevan characterised the settlement as meaning that the Department did not have "all the capital we want, [but] all the capital we need".[43]

32. Following the evidence session, Simon Fraser wrote to us with further information on the security upgrades planned in Indonesia and Yemen. The Treasury has given approval for new Embassy buildings in Jakarta and Tel Aviv, estimated to cost £29.5 million and £19 million respectively.[44] Mr Fraser's letter emphasised that this purchase was "security driven". In addition, in the light of the terrorist threat in Yemen, the Post in Sana'a will receive £2 million of security upgrades funded from a re-prioritisation of the capital budget. A "project to house staff securely in the longer term" will be looked at "urgently".[45]

33. Both our predecessor Committee and the NAO have criticised past examples of poor estates management by the FCO.[46] Simon Fraser acknowledged that "it is probably true that the estates management record of the Foreign Office over quite a long period of time may have left something to be desired", but he insisted that the Department "have introduced a number of measures to improve our performance". Mr Fraser also told us that while "I absolutely take the point about the desire not to sell off valuable properties [...] we need an ambition for efficiency [and] modernity [...] so we have to get the right balance in managing the estate".[47] James Bevan insisted that the FCO was not going to achieve its recycled assets target by "sell[ing] off the icons". He said that "the embassy in Paris is a classic example of a building that pays its way because it is so effective as a representational tool". However, he continued:

there are [...] a bunch of other buildings across the world that are neither iconic, nor fit for purpose—in some cases they aren't even safe. Those are precisely the kind of buildings that we want to get out of and downsize into more modern, appropriate accommodation.[48]

34. We conclude that cuts of 50% in the FCO's capital spending will severely impact on the Department's estates management. As priority for the remaining money will quite rightly be given to much-needed improvements to overseas security, the likelihood is that 'routine' modernisation and upgrading to Embassy premises will largely be put on hold for the four years of the Spending Review period.

35. We further conclude that the target of raising about £50 million per year for the capital budget through selling existing buildings may be difficult to achieve, and may not secure savings in the long-term. This target may create an unwelcome incentive to sell historic or prestigious buildings which have a potential long-term value to the FCO greater than any immediate monetary benefit likely to accrue from their sale.

36. We recommend that the FCO, in its response to this Report, should supply us with a list of overseas properties which it proposes either to modernise or sell, updated to reflect the changed circumstances following the SR2010 settlement.

Staff reductions and the 'localisation' policy

37. Announcing the Spending Review to the House, the Chancellor of the Exchequer said:

Savings of 24% in the Foreign and Commonwealth Office budget will be achieved over the review period by a sharp reduction in the number of Whitehall-based diplomats and back office functions.[49]

38. In 2009-10, the FCO employed over 13,500 permanent members of staff, of which 65% were located overseas.[50] These staff comprise:

UK-based staff, who are recruited in the UK for potentially complete careers, during which they will typically serve in a variety of positions, both in the UK and overseas, and who are paid throughout in Sterling; and
Locally engaged (LE) staff, who are recruited in-country for specific jobs in particular overseas missions, and employed by the mission concerned rather than the FCO 'proper'. LE staff are usually nationals of the country where they are employed, although not necessarily; increasing numbers of LE staff are British, especially in cities—such as in continental Europe—where there may be a significant pool of resident British potential employees. As non-permanent staff who do not sign up to the global mobility obligation of UK-based staff, LE staff do not have the same terms and conditions as their UK-based counterparts. LE staff are paid in local currency. Around two-thirds of overseas positions are filled by LE staff.[51]

39. The Permanent Under-Secretary at the FCO, Simon Fraser, informed us that before the Spending Review announcement, the FCO "planned to reduce numbers of UK staff by 10% [...] a 2% year on year reduction," through its Strategic Workforce Plan. He explained that this plan will be revised to cover the Spending Review period. He stated that:

The flat cash settlement equates to around a 2.5% per year real terms budget reduction and we expect the UK-based workforce to shrink at about this rate, making use of natural wastage, early retirement and voluntary redundancy as far as possible, including the recent autumn early retirement exercise, under which around one hundred staff left.[52]

40. On 21 October, The Times reported that the FCO will lose at least 430 of its 4,300 British employees, and that most of the economies will "take place at the expense of diplomats based in London and administrative staff, with cuts concentrated on the diplomatic and cultural aspects of the FCO's work".[53]

41. For some years the proportion of locally engaged staff employed by the FCO has been rising: from 59% of staff in 2003 to 66% in 2009.[54] As a consequence of the Spending Review the policy of 'localisation' of posts will continue; as Simon Fraser told us, "it is in most cases cheaper to do that".[55] He added, however, that saving money was not the only consideration: "sometimes you can attract highly qualified people with strong local contacts and experience who actually add to our ability to perform".[56]

42. The localisation policy entails certain risks, notably that of diminishing the opportunities for more junior UK-based staff to gain experience of overseas postings. Arguably, this leads in due course to reduced levels of diplomatic experience among senior staff (including language skills and experience of other countries' political culture), and a consequential impact on morale and effectiveness. In addition, the reduced number of UK-based staff within each post may have to devote a greater proportion of their time to managing the LE staff, and may therefore have less time available to devote to their core functions as diplomats.

43. Our predecessor Committee, in its Report into the FCO's 2008-09 annual report, commented:

We conclude that locally engaged staff make an important contribution to the work of the FCO, and bring considerable value to the organisation. However, we also conclude that their use in a growing range of jobs, some at an increasingly senior level, carries risks for the Department. We would be concerned if the localisation of FCO jobs were being driven purely by cost considerations. [...] We further conclude that the localisation process requires careful management in terms of its impact on UK-based staff.[57]

44. The Public and Commercial Services Union (PCS) wrote to us, expressing concerns among its members:

We also have a situation now where more junior posts overseas are fast disappearing. Traditionally this was a good method to allow younger recruits to get some experience of living and working overseas before going onto more senior postings. Increasingly the first posting for staff is now at a more senior level without having first gained the valuable experience of an overseas posting at a more junior level.[58]

The PCS notes that not only does this policy reduce the number of staff posted overseas, but those who remain take on a higher workload as certain tasks can only be performed by UK staff for security reasons. The PCS goes on to doubt the cost savings that such a policy can bring, telling us that:

we are not even sure localisation saves as much money as the FCO claim. Two years ago they said it would save £14 million a year, last year that was down to £12.5 million a year and the figure now quoted is around £10 million.[59]

45. In our evidence session with departmental officials, we raised these concerns. Simon Fraser agreed that greater localisation would have structural implications for the Department and that at junior levels it led to fewer opportunities for UK-based staff to go overseas.[60] James Bevan, FCO Director General Change and Delivery, spelled out the consequences: "even five years ago, if you were a junior UK Foreign Office employee, you could expect to spend two successive postings abroad and one posting back in London. The ratio is now one abroad to one in London."[61] In supplementary written evidence to us, Simon Fraser stated that the "localisation initiative is forecast to save approximately £12 million annually from 2012-13 [while] also delivering other benefits through recruitment of talented local staff".[62]

46. We note that two-thirds of staff in the FCO's network of overseas posts are locally engaged, and that it is likely that the proportion will increase further as a consequence of the FCO's intention, following the Spending Review, to reduce its UK-based workforce by about 2.5% per year. We conclude that the FCO's 'localisation' policy has brought benefits, but we do not believe that it is capable of indefinite extension. A further reduction in the opportunities for more junior UK-based staff to serve in overseas posts, and a consequent diminishing of experience and morale among FCO employees, will over time have a damaging effect on the quality of British diplomacy and the effectiveness of the FCO.

47. We recommend that in its response to this Report, the FCO should supply updated information on its localisation policy. This should include a list of all overseas Posts, giving in each case the ratio of UK-based staff to locally engaged staff as it (a) was five years ago, (b) is currently, and (c) is expected to be in any future years for which projections have been made. We further recommend that the FCO should explain how decisions to localise jobs are made in individual cases, and what steps are taken to ensure that these individual decisions reflect the FCO's overall strategic need to retain a suitably sized pool of staff with overseas experience.

Overseas Posts

48. The FCO operates a network of over 250 Posts in over 170 countries. These Posts comprise sovereign Embassies, High Commissions (to Commonwealth countries) and Missions, Delegations and Permanent Representations to international organisations; and subordinate ones, comprising consulates and trade and other representative offices. There is also a network of Posts in 12 of the 14 Overseas Territories (OTs).[63]

49. Both before and after the 2010 General Election, there had been speculation that the FCO would be obliged to close Embassies or other overseas Posts in order to make savings. FCO officials and documents had previously indicated that Post closures would be unavoidable without some relief for the Department's budget.[64] In July 2010, The Times reported that plans had been drawn up to close several Consulates, and Embassies in South America, West Africa and Europe.[65]

50. Since taking office, the present Foreign Secretary has consistently said that he will give a high priority to avoiding Post closures. Mr Hague told the Financial Times in July 2010 that "you have to have a presence in most countries in order to be able to assist British business".[66] In September, he told us that "the FCO network is an essential part of the infrastructure of this country for economic recovery".[67]However, he added that the network was not "ring-fenced" and that there was "scope for adjustment here and there".[68]

51. Mr Hague commented that the FCO's network represents good value for money. For example, he compared the cost of the network with that of the French diplomatic service: "France, with a budget of nearly £4 billion, has 279 missions overseas. We have 261 [...] We have a little over half of France's budget with which to maintain almost the same number of missions."[69] Anticipating the scale of cuts likely to be required by the Spending Review, Mr Hague expressed doubt as to whether significant savings could be made from the closure of Posts. He said:

if you closed the 40 cheapest posts—we have 261 posts—you would save only £2.5 million. That is why, whatever we have to do with our budget, it is quite unlikely that one would choose the option of closing dozens of posts. We are not engaged in some large reduction of our international network.

I hope that that trade-off between those large and small posts will not have to be made; it is certainly not one I am intending to make. Closing the small missions around the world is a false economy on the whole. That is not to say that they cannot sometimes be rationalised or that two countries cannot be well served together from one central point. I think in general, however, that the reduction and withdrawal of this country's diplomatic presence—something that we know has taken place in large parts of Africa—is a mistake. With all these budgetary restrictions, I cannot reverse what has happened in the past, but I am not looking at making serious further reductions in the size of that network, and I think that it would be a major national error to do so.[70]

In written evidence dated 12 November 2010, Simon Fraser stated that the Spending Review settlement would impact on the overseas network and that "savings" would come from spending less on upgrading embassies and from selling off some property abroad. He also stated that the FCO would have to make "strategic decisions" on "what we do, and how we do it" and "whether our existing network of Posts adequately meets the new realities". He commented that:

The Foreign Secretary is clear that Britain will continue to need a global diplomatic network, not least to promote our commercial interests to help bring the UK economy back to long-term health. We have no plans—and in the light of SR10 no need—for widespread post closures. We will report any major decisions to Parliament.[71]

52. In oral evidence, Mr Fraser told us that maintaining a "global network of diplomatic posts" is a "top priority", but he added that "the Foreign Secretary's view does not mean that we have to stick with the network we have [...] For example, we may want to open some new posts and we may want to close some other posts to fund that".[72] Mr Fraser told us that some posts will close to fund new sites in "emerging markets—those areas where economic growth and greater political weight are shifting in the world".[73]

53. A further development which may have an impact on the FCO's staffing policies in its overseas posts is the creation of the European External Action Service (EEAS), which was instituted on 1 January 2011. Under the provisions of the Lisbon Treaty, the EEAS is being set up as a new, single service bringing together departments and officials currently in the European Commission, departments and officials currently in the Council Secretariat, and seconded national diplomats, under the authority of the new EU Representative for Foreign Affairs and Security Policy (Baroness Ashton). Over 130 EU Delegations have been established in third countries, by converting the previous European Commission Delegations. The new Delegations will be given upgraded powers: for instance, Heads of Delegation will be authorised to speak publicly in the name of the EU (on the basis of statements pre-approved by all 27 Member States). It is likely that further EU Delegations will be established in new locations, and some existing Delegations, such as that to the United Nations in New York, may be significantly expanded.[74]

54. In March 2010 the then Permanent Under-Secretary at the FCO, Sir Peter Ricketts, told the Public Accounts Committee that the opening of EU Delegations around the world could see the FCO sharing space in Posts with EU representatives or even "putting one British diplomat or two British diplomats in to a wider [EU] operation [...] I think over time we will move in that direction".[75] However, in its response to our predecessor Committee's Report, the previous Government gave an assurance that "the establishment of the EEAS will not lead to our Embassies being replaced with Union Delegations [...] They will complement, not replace national diplomatic networks".[76]

55. We recommend that, in its response to this Report, the Government should supply us with an assessment of how the future development of the European External Action Service is likely to impact on the work of the UK's global network of Posts. We further recommend that the Government should reconfirm the undertaking given by the previous Government to our predecessor Committee in April 2010 that "the establishment of the EEAS will not lead to our Embassies being replaced with Union Delegations".

Foreign Currency Mechanism

56. One of the key areas of the FCO's financial settlement is the "creation of a new Foreign Currency Mechanism [which] will restore some protection for FCO purchasing power overseas".[77] A previous scheme, the Overseas Price Mechanism (OPM), was withdrawn in 2007. The OPM gave the Department's spending in foreign currency some protection against exchange-rate fluctuations and thereby maintained the purchasing power of its budget in local currencies. Under the OPM, every six months the Department calculated the net effect of exchange-rate fluctuations and differential inflation rates on its overall purchasing power overseas. When Sterling had strengthened, increasing the FCO's purchasing power, it returned money to the Treasury. When the FCO lost out because Sterling had weakened, the Treasury made up the shortfall.

57. In order to offset some of the effects of fluctuations in foreign exchange rates and to aid budget stability, the FCO reacted to the removal of the OPM by beginning a programme of forward purchasing of foreign currency. During 2009-10 the Department bought £610 million of US Dollars, £103 million of Euros and £1,115 million of Yen under long-term contracts. This spending covered around 90% of its spending in foreign currencies. These contracts gave a degree of budget certainty but did not protect the Department against gains and losses. In 2009-10, the FCO estimated that in the absence of the OPM it had lost around £142 million to exchange-rate fluctuations caused by the weakening of Sterling.[78] Our predecessor Committee criticised the removal of the OPM and the process by which it was withdrawn.[79]

58. The Spending Review announced the creation of a Foreign Currency Mechanism (FCM) which would cover exchange-rate fluctuations but not differential inflation rates—the impact on purchasing power of different overseas inflation rates. In a note to us, the NAO explained that under the new system the FCO would be compensated for any falls in the value of Sterling below the baseline rate (as set in October 2010). Any strengthening of Sterling above this rate will see funding returned to the Treasury. The Foreign Secretary has praised this system as being "less bureaucratic" and "more transparent" than the previous OPM.[80] The Permanent Under-Secretary, Simon Fraser, elaborated on the remit of the new FCM, confirming to us that it will extend not only to Post budgets, but also to foreign currency movements in estates, security, capital and programme expenditure.[81]

59. James Bevan told us that the new scheme would protect a greater part of the FCO's budget against foreign exchange fluctuations than the OPM and was therefore a "significant improvement". However, he conceded that the absence of protection against differential inflation rates would leave the Department prey to higher inflation rates, particularly in fast-growing, increasingly important, countries such as Turkey, Brazil or India, and that this would make "dealing with the [overall] budget more challenging than it might appear."[82] He also noted that the new arrangements in place would not cover the spending in foreign currencies under the peacekeeping budget which would remain the responsibility of the MOD.[83]

60. We conclude that the introduction of the Foreign Pricing Mechanism is a welcome step. However, we are concerned that the new mechanism does not make allowance for differential inflation rates and may leave the FCO's budgets prey to steep inflation in other countries. We recommend that the FCO keep the operation of the new system under close review, and that if differential exchange rates entail significant losses to its budget, it should seek to reopen negotiations with the Treasury over amending the FPM to include some degree of compensation for this.

Overseas Development Assistance

61. The Coalition Government has re-affirmed the UK's long-standing commitment to the United Nations target of spending 0.7% of its gross national income (GNI) on Overseas Development Assistance (ODA). DFID estimate that this target will be met in 2013 when the total spend on ODA is expected to have risen to around £12 billion. The FCO currently contributes around 2% of the total UK spend on ODA. This is projected to increase to around 2.4% in 2011-12.[84]

62. ODA is classed by the OECD as a "financial transfer from an official agency to a developing country or multilateral institution which has the economic development and welfare of developing countries as its main objective". Under this definition, the FCO defines three aspects of its spending as ODA:

Some Strategic Programme Funds, including those supporting action on climate change, governance and human rights capacity building;
A proportion of the UK's contributions to the UN regular budget, and to the Commonwealth Fund and Commonwealth Small States Fund; and
A proportion of the FCO's Grant-in-Aid to the British Council.

63. In his memorandum of 12 November, Simon Fraser was keen to highlight that "the FCO family's contribution to UK Overseas Development Assistance (ODA) spending has increased to £273 million per year". He did not yet know precisely how this increased funding would be spent, but suggested that it would be through a continuation of current work and the introduction of new ODA-eligible activities. He also noted that the FCO would look closely at "reclassification" as:

in the past we did not score some FCO activities which could count as ODA. In a tight public expenditure environment, it's only fair to taxpayers that all eligible expenditure is counted. So we will ensure, working with the OECD and DFID, that all FCO work which should legitimately be scored as ODA in areas such as stopping conflict, promoting good governance, capacity building and supporting economic development.[85]

64. In our oral evidence session with Mr Fraser, he again stressed the increased FCO spend on ODA. James Bevan provided us with more details:

The Foreign Office core, outwith the British Council and the World Service, has to go from our current ODA spend of about £90 million this year, to about £150 million ODA spend, starting next financial year, and maintain that for the four years of the Spending Review [...] the way we are going to do that is partly by maintaining existing Foreign Office activities that already count as ODA, of which the main one is our programme activity [...] We will maintain those programmes, with some adjustments, and we will do some additional ODA activity that we have not done previously, which will probably include some more programme activity. There will be a proportion, which we have not yet finalised, where we will reclassify as ODA activity that we have not previously scored as ODA.[86]

65. This process of reclassification is under way in the British Council. On 27 October 2010, the Foreign Secretary wrote to us:

I am asking the [British] Council to devote a proportion of new surpluses to activities in support of their charitable objects and the FCO's international priorities in order to maintain their reach and impact. I am also asking the Council to meet an ambitious ODA target, and I expect to start a strategic dialogue with the Council quickly to agree how best to maintain the Council's significant global impact, and target it to greatest effect in these new circumstances.[87]

66. Giving evidence to us on 3 November, Vernon Ellis, Chair of the British Council, said that, at present, £40 million of British Council grant was classified as ODA, but that this could be increased "still further". Martin Davidson, Chief Executive, identified "English for development, the development of higher education and education [...] and the work of arts within development" as areas of the Council's work that fell within the OECD definition of ODA.[88] He explained that British Council activity totalling £40 million had "traditionally always fallen within the ODA definition, because that part of the grant was given to us from DFID about 10 years ago". However, he estimated that "double that figure could possibly be submitted".[89]

67. We pursued the question of reclassification with the Department. We were curious as to why reclassification was needed and why it would therefore appear that ODA had not been categorised accurately in the past. We were given two main reasons for this. James Bevan told us that the FCO did not contribute much to the UK's overall ODA-spend, suggesting that, until the recent Spending Review, the Department had not looked closely at its ODA-spending. Mr Bevan also argued that compared to some other countries, the UK had "always had a pretty restrictive definition" of what could be classed as ODA.[90]

68. We conclude that, while the Government's commitment to meet the long-standing international obligation to spend 0.7% of gross national income on Overseas Development Assistance is welcome, there is a danger that 'reclassification' provides a cover for meeting the 0.7% of GNI target without increasing the money actually spent on ODA.

69. We recommend that, in its response to this Report, the FCO should give us a detailed breakdown of items of Departmental expenditure which it is proposed to reclassify as ODA, indicating in each case why they were not previously so classified, and noting whether the OECD and DFID have approved the reclassification.

The Conflict Prevention Pool

70. The Spending Review settlement covers both Assessed (or obligatory) Peacekeeping costs and the Conflict Pool which funds discretionary activity aimed at preventing and resolving conflict. The Treasury will continue to provide £374 million annually from its Reserve, as in the previous spending round, for the Assessed Costs of peacekeeping. The Government states that "we expect the actual costs of our international peacekeeping obligations to be more than £374 million in each year of the Review period", and therefore "money from the Conflict Pool will need to be used, as at present, as the first port of call to top up the peacekeeping budget".[91]

71. The Conflict Pool is co-managed between the FCO, DFID and the MOD to support conflict prevention in many countries. Funding is channelled to the other two Departments through DFID. The Pool funds five programmes dealing with: Wider Europe, Africa, Middle East, South Asia and Strategic Support to International Organisations. The tri-departmental Stabilisation Unit is also funded from the Pool. Conflict Pool allocations for 2011-12 to the individual Departments are expected to be announced to Parliament shortly.[92] The budget for the Conflict Pool in 2010-11 is £229 million, which will increase to around £309 million in 2014-15.[93]

72. The Spending Review settlement separates funding for the Government's international peacekeeping responsibilities and the financial risks that accompany them from the FCO's baseline. However, the FCO will continue to report this expenditure to Parliament.[94] Keith Luck, FCO Director General Finance, told us that this "significant change [...] will reduce the exposure and the risk that the Foreign Office is open to in terms of managing its budget".[95]

73. We conclude that the removal of the funding of peacekeeping operations from the FCO's baseline is a welcome development, one which will reduce the overall financial risks faced by the Department. We recommend that in its response to this Report, the FCO should supply a detailed breakdown of the FCO's latest allocation from the Conflict Pool and the uses to which it will be put; and that it should also supply us with its latest estimate of the extent to which the budget for peacekeeping operations will need to be 'topped up' from the Conflict Pool.

6 Foreign Affairs Committee, Oral evidence transcript, Developments in UK Foreign Policy, 8 September 2010, H438-i, Q 15 Back

7 Analysis provided by the House of Commons Scrutiny Unit. Back

8 According to the FCO's 2009-10 Resource Accounts, subscriptions to international organisations were £177,412,000 out of Net Operating Cost of £2,345,107,000 (7.6%). Back

9 Q 9; Foreign Affairs Committee, Developments in the European Union, Oral and written evidence, 9 December 2009, HC (2009-10) 144, Q 4 [David Miliband]; HL Deb, 20 January 2010, col 993; HC Deb, 21 January 2010, col 439; the budget referred to is the DEL budget. Back

10 Q 9; HC Deb, 8 December 2009, col 240-1W; HC Deb, 21 January 2010, col 439 Back

12 Foreign Affairs Committee, Fifth Report of Session 2009-10, Foreign and Commonwealth Office Annual Report 2008-09, HC 145, paras 51-57; FCO, FCO Resource Accounts 2009-10, HC 74, 30 June 2010, p 3 Back

13 Foreign Affairs Committee, Foreign and Commonwealth Office Annual Report 2008-09, para 132 Back

14 FCO, FCO Resource Accounts 2009-10, pp 4 and 28 Back

15 Foreign Affairs Committee, Foreign and Commonwealth Office Annual Report 2008-09, para 40; FCO, FCO Resource Accounts 2009-10, p 41 Back

16 Foreign Affairs Committee, Fifth Report of Session 2009-10,Foreign and Commonwealth Office Annual Report 2008-09, para 35 Back

17 FCO, FCO Resource Accounts 2009-10, p 3 Back

18 FCO, Annexes to the FCO Resource Accounts 2009-10 Back