{This article is also published in our March 2014 issue of Latin American Regional Report: Caribbean & Central America.}
On 6 March, Cuba’s government confirmed that it plans to abolish the ‘convertible peso’ (CUC), and provided instructions for businesses for the day when that happens. But it did not give any date, or specify the new exchange rate.
A cautious path to reform
The announcement was low-key, with a short article on an inside page of the official Communist Party newspaper, Granma. This referred to publication of a special edition of the Gaceta Oficial (Official Gazette), which sets out instructions for adjusting accounts and setting prices on the day that currency unification is announced, as part of an established process in line with government policy, as set out in previous statements.
The intention to unify the currency system was included in the ‘lineamientos’ (policy guidelines) approved at the 2011 Communist Party congress, and the most recent statement on the subject was an official note published in October 2013, which merely confirmed that a timetable had been agreed, without giving details. Nonetheless, the new document represents an important step. It provides the first confirmation that currency unification is to be achieved by the abolition of the convertible peso (CUC) and demonstrates that preparations are well under way.
The currency reform will have an enormous impact on relative incomes, prices and economic growth and development. Once complete, it will be a major step towards removing the huge price distortions that currently exist within the Cuban economy. At present, the value of the CUC is fixed at par with the US dollar (CUC1:US$1), and it is convertible for foreign currency at Cuban banks, but cannot be exchanged outside the country. There are two exchange rates between the CUC and the domestic currency, the Cuban peso (CUP), and they are far apart: the CUP is overvalued at the official rate, used for accounting purposes by state entities, at one CUP per CUC, and undervalued at the ‘Cadeca’ rate, used for personal transactions and by the growing private sector, at CUP24:CUC1.
The separation of the external and domestic economies resulting from the dual exchange rate system not only creates a wide gulf between relative incomes, but also obstructs the linkages required to diversify exports, substitute for imports or send price signals to boost productivity.
Exchange rate reform would imply that the CUP would become convertible within Cuba at a new rate fixed by the authorities. No indications have been given concerning the rate of exchange for the CUP to be used after the abolition of the CUC. In recent months, some pilot studies have been carried out using exchange rates of between CUP12:CUC1 (that is, 12 CUPs per US dollar) and CUP7:CUC1 (7 CUCs per US dollar) for transactions between some enterprises.
However, these rates do not necessarily indicate the rate that will be used: officials acknowledge that conditions prevailing in such isolated experiments are quite different from the circumstances of an exchange rate adjustment on a national scale.
Detailed instructions for ‘día cero’
The three resolutions (19/2014, 20/2014 and 21/2014) published in the Gaceta Oficial describe, in detail, the procedures that enterprise accountants will need to carry out on the day when the CUC is abolished, referred to as ‘día cero’ (day zero).
Resolution no.19/24 explains how monetary and stock balances are to be reported, and Resolutions 20/2014 and 21/2014 provide instructions for setting wholesale and retail prices respectively. The details are complicated, with prices to be set by a combination of a ‘cost-plus’ rule and conformity to international and domestic market prices. Official approval has to be sought for the initial prices, with the ministry of finance and prices responsible for containing any inflationary surge and deciding whether some prices can be set below cost price (and therefore receive state subsidies). The Granma article makes it clear that in the process of training staff and trying out the procedures before ‘día cero’, further refinements are likely.
Disruption and risk can be minimised, but not avoided
The central aim of the approach taken to currency unification is to minimise the economic shock. These instructions are designed to guard against speculative gains, control price instability and identify winners and losers from the change, to make it possible to arrange compensation if necessary. However, uncertainty, disruption and confusion cannot be eliminated, and any adjustment in relative prices is certain to create winners and losers. The government has therefore embarked on a project that, while necessary to escape from economic stagnation, carries high risks.
The timing of the change will be one factor in the management of risk. The intention appears to be to make a decision on when ‘día cero’ happens following this next stage, of preparation and training. In line with President Raúl Castro’s mantra, ‘sin prisa, pero sin pausa’ (without haste, but without pause), the launch of the documents means that the public is now expecting the change by the end of this year. Any further delay will require explanation. It is likely that the government will seek to avoid the summer months, when household budgets are stretched by school holidays (with the cost of feeding children at lunchtime borne by families rather than the ministry of education), which means the CUC’s abolition will have to take place within the next four months or after six. The change is likely to require a bank holiday, to allow for managers to complete accounts and adjust prices before business resumes.
The critical decision will be the determination of the exchange rate. It appears that a decision on this has not yet been taken, with the results of the calculation of inventories, costs and prices to be taken into account. An advantage of keeping the rate close to the ‘Cadeca’ rate of CUP24:UC$1 would be that it would not put pressure on foreign exchange reserves and would leave room for further revaluations once relative prices had settled and confidence had been built. It would also mean a very sharp improvement in the competitiveness of state enterprises.
But if the exchange rate is too weak and the CUP remains undervalued, the extremely low value of real incomes would require a continued high burden of subsidies to provide a minimum standard of living, and the effect would be to entrench the Cuban economy into the international market as a low-wage producer. It would also perpetuate the gap between the majority, who currently earn CUP salaries (whose living standards remain severely depressed), and the privileged minority with CUC incomes.
A bolder adjustment, to CUP10:US$1 or more, would provide a beneficial correction in relative real incomes, while also introducing some improvement in competitiveness and flexibility for state enterprises. Such an adjustment would imply a reduction in profits for many non-state enterprises and in the relative income advantage for households dependent on remittances, which could cause temporary hardship in some cases. But, by the same token, it would help to boost productivity in the non-state sector. The limits to the CUP’s value depend on the demand and supply of foreign exchange, and the outcome can only be estimated.
Efforts to mitigate the initial shock have to be balanced against the potential cost of building in exchange rate and price rigidities that recreate existing obstacles to economic dynamism. If, as hoped, the initial currency reform leads to productivity gains, it could allow room for an eventual further revaluation and higher living standards. In the meantime, the government is attempting to manage a process of unsettling uncertainty and deep structural transformation.
For more discussion and analysis, please see the forthcoming (March 2014) edition of our Latin America Economy & Business Report. LatinNews also published a White Paper on currency reform in Cuba in September 2013, ‘Cuba's dual currency system: the need for urgent reform’, in which the academic economist and Cuba expert Dr. Emily Morris and the consultant economist Andrew Hutchings examine the current economic and political situation in Cuba and put forth proposals for currency reform in the context of the Cuban government’s moves to address this key issue. This timely and well-received report remains available for purchase.
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