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The "ludicrous" decision to stop protecting the Foreign Office budget from fluctuations in exchange rates has caused an "unacceptable risk" to its ability to function properly, MPs have said.
A sharp fall in the value of sterling had caused a 13% drop in the FCO's core purchasing power since the system was axed in 2007, the Commons Foreign Affairs Committee found, sparking cuts in embassies and postings around the world.
The cuts caused a political row earlier this year when the Tories accused the Government of undermining Britain's global interests by scrapping the special fund that provided insulation from movements in the pound.
And the influential cross-party committee said the financial constraints under which the FCO was now operating were "unacceptably disrupting and curtailing" its work.
"We cannot see that it remains credible to regard the costs of currency fluctuations as predictable ones which the FCO might reasonably be expected to absorb," the committee said in its report.
"The cuts that the FCO is making at its overseas posts represent a serious reputational risk to the department and the UK, and thus a threat to the FCO's effectiveness," it said.
"Given the dispersal around the world of potential threats and areas of concern to the UK, and the large numbers of British citizens who travel widely overseas, closures of FCO overseas posts risk leaving potentially damaging gaps in UK information-gathering, provision of assistance and exercise of influence."
Committee chairman Mike Gapes said it was essential that the FCO had the resources it needed to carry out its traditional policy-making functions.
"For reasons largely beyond its control, the FCO's financial situation has come to represent an unacceptable risk to the department's ability to perform its functions," he said.
"Exchange rates should not drive UK foreign policy. At a time when globalisation is acknowledged as the key phenomenon of our times, it is incongruous that the position of the only government department with a global reach is threatened with erosion."
