Cuban economist predicts ‘Day Zero’ for currency merger

Cuba Standard

By Vito Echevarría

CUBA STANDARD — A leading Cuban economist believes “Day Zero” of currency unification for businesses and government institutions is just a few months away.

Pavel Vidal, a former Central Bank economist who currently teaches at the Pontífica Universidad Javeriana in Calí, Colombia, raised eyebrows at a recent conference in New York when he said he believes that a key step in one of Raúl Castro’s most dramatic economic reforms — the unification of the Cuban peso for companies and government institutions — is approaching at the beginning of 2015 (the currency merger for consumers in the Cuba government’s step-by-step approach will occur at a later date).

The topic that stirred most interest during a conference on Cuba in late May at the CUNY Graduate Center in New York was the future of the Cuban peso and its impact on living standards, as well as on foreign investment.

For more than 20 years, the country has lived under a two-currency system, with local workers being paid in Cuban pesos (CUP) (worth about 24 pesos to the dollar), while many goods and services are available only in convertible Cuban pesos (CUC) (pegged more or less on par with the dollar). Foreign investors operate almost exclusively with the CUC.

Cuba’s Ministry of Finance and Prices (MFP) published a series of resolutions on the future of the Cuban peso in the Gaceta Oficial last March, and mentioned a Día Cero as the time when the dual currency system will be eliminated for businesses and government institutions. But it didn’t provide a date.

“I believe that Día Cero will be in January 2015, given the annual cycle that the [Cuban government] plans the economy,” Vidal told Cuba Standard. “By September 2014, [Cuban] enterprises must submit to the Ministry of Economy and Planning (MEP) their plans for 2015, so that they are approved.”

“There is no total certainty, but it’s very probable,” he added.

Vidal also predicts a 10:1 exchange rate.

“It’s likely that these plans have already incorporated the exchange rate of 10 CUP:1CUC (10CUP:1USD). The resolutions are aiming to regulate pricing and accounting practices once the CUP is re-established as the only currency for transactions in the business sector.”

Vidal feels that when Día Cero occurs, it will be swift, in order for the government to control the pace of such a dramatic change in the island’s economy.

“Certainly, one of the disadvantages of a step-by-step, anticipated currency reform is more uncertainty and opportunities for speculation,” he noted.  “Cuba’s economic authorities count as a factor in their favor their control over capital flows,” he added.

Vidal didn’t discard the possibility of currency speculation among segments of the island’s population.

“Even though the resolutions only refer directly to the business sector, they have triggered expectations and reactions among citizens,” he said. After the Gaceta Oficial’s March 2014 publication about Día Cero, a growing number of locals reportedly exchanged their CUCs for CUP at state-run CADECA currency-exchange shops.

A World Bank skeptic

Another participant at the CUNY event was critical of the Cuban government’s gradual approach to currency reform. Augusto de la Torre, chief economist (Office of Latin America and the Caribbean) at the World Bank in Washington, told attendees that Cuba’s “dual-rate system is a fiscal scheme of large but implicit taxes and subsidies” (with the Financial Times calling this a “95% sales tax”), and mentioned that an exchange rate unification would require fundamental fiscal reform. He notes that the Cuban government’s best option is for swift implementation of the peso reunification.

De la Torre, an Ecuadorian who has worked with the World Bank since 1997 and previously headed the Central Bank of Ecuador, recommends a series of measures called the “fiscally-cushioned Big Bang” — unifying on Day One the island’s two exchange rates at 24:1, in order to limit balance of payment pressures. “Replace on Day One the dual rate-based shadow taxes and subsidies with equivalent but efficient lump-sum taxes and subsidies for existing enterprises,” he urged.  De la Torre said that such actions should adequately cushion the blow of a dramatic currency reform.

Noting that Cuba has perhaps the largest-ever known spread between exchange rates under its current dual currency system, de la Torre said that “this highlights the importance of tight monetary control [by the government] during and after unification”, and spotlights the dangers of taking a gradual path to achieve this goal.

He also said that Cuba’s “sector-by-sector gradualism” is problematic, because “much of the supply response would be postponed”. There is “policy uncertainty — discretionary adjustments with risk of incomplete reform,” he said. An “even greater multiplicity of exchange rates would segment markets, and so distort price signals as to impede efficient resource allocation across sectors.”

De la Torre said that Cuba should also avoid a third currency reform option, called “economy-wide gradualism”. Under that scenario, the pain of currency reunification is spread out over time, but addresses the “pain/gain balance” insufficiently. “There is a clear risk of a self-fulfilling failure,” he said, impacting in particular foreign investment opportunities. “Investors wait, [this] raises transition costs, forces abandonment of [the] pre-announced path, and justifies waiting” for completion of currency reform.

De la Torre insists that the Cuban government must follow through on currency reunification, since the current system entails huge efficiency losses, and hurts the country’s attractiveness to badly-needed foreign investors. “It discourages employment, undermines quality of service, hinders new foreign direct investment, reduces tourism inflows, and promotes stealth employment,” he said. “The 2,300% [exchange rate] spread implies a heavy tax on local labor, hence high labor costs for the foreign-owned or managed tourism industry.”

De la Torre also commented that Cuba stands out, since it is not a member of multilateral institutions like the IMF, the Inter-American Development Bank, or the World Bank, and is thus unable to turn to such institutions for support in its path toward currency reform. “Cuba’s limited access to international finance is an additional complication,” he said.  “Concessional (international) finance could greatly facilitate unification.”

Vicious circle of low salaries

One CUNY attendee who spoke on background said that the reunification of the Cuban peso could resolve what some called the “vicious circle” of low salaries and low productivity that has long existed on the island.  “Productivity in Cuba can go up once workers are given salary-driven incentives,” he said. “The consumerism that would accompany more buying power can indeed help the local economy grow, driving the production of more locally-made goods and services.”

In the case of the Mariel Special Development Zone (ZEDM), the state agency employers must use for hiring only withholds 20% of the salary — much less than before — but pays workers in Cuban pesos (CUP). For the conversion of salaries to Cuban pesos, an exchange rate of 10CUP:1USD was established, closer to market rate. Despite withholding and pay in CUP — as well as high income taxes — this should make jobs at Mariel very attractive for Cuban workers.

“For the remainder of companies with foreign capital, there will be changes in salaries, but their magnitude has yet to be known,” Vidal said. “State companies will be able to decide their compensation system, and increase salary levels according to their financial capacity, as long as the relation of median salary/productivity doesn’t deteriorate.”