Cuba’s currency unification

Analysis: Cuba's currency unification

By Domingo Amuchastegui



Cuba's reforms and changes, aiming at a complete redesign of its rigid,

state-controlled socialist experience, has come to a point of no return.

There's no turning back, and the Achilles Heel of this present stage is

the effort to put an end to the two-tier currency system, with all its

distortions in finance, accounting, incentives, productivity, and social

differences.



Although the Party's Guidelines (Lineamientos) announced currency

unification in 2011, it was only in October 2013 that the government

disclosed a timeline, without details or specific dates. A Granma

article on Oct. 22 was clear: "It is imperative to guarantee the

re-establishment of the Cuban pesos's value and its role as currency, as

a unit of accounting, means of payment, and of savings. Since then, a

debate has ensued among academics and observers over what analyst David

Brunat has called "the most sensitive subject Cuban lawmakers are to

face in the economic sector."



Any discussion must consider two contexts.



One is the current state of the Cuban economy and the legacy of the past

20 years of coping with the downfall of Soviet-style socialism. A

partial recovery has taken place, but GDP growth is still less than 3%,

well below the 5-7% growth generally deemed necessary. To be sure,

despite ample criticism of this fact, one conclusion remains valid: The

government decided to distribute the cost of the crisis among state

employees, instead of "sending thousands of families to absolute

poverty," as economists Pavel Vidal and Omar Everleny Pérez Villanueva

put it in a Brookings Institution-sponsored conference in December.



A few structural issues that have not been dealt with deserve special

attention:



•There is a humongous problem with nearly 3,000 state companies,

representing two-thirds of the economy and some 2 million workers: They

were not profitable in 1960s, they were not profitable in the 1980s, and

they are not profitable today. The government continues to subsidize

their activities, resulting in damage to budgets, salaries, output, and GDP.



•These industry and service companies are, for the most part, operating

with machinery, tools and other supplies dating back to the Soviet, or

even pre-1959, era, and incapable of meeting their production goals and

financial obligations.



•These state companies are the Number One source of losses and defaults,

causing deficits and disruptions in their relations with other state

companies and the national banking system, wreaking havoc on process and

causing corruption. "Cuban economists say one of the most complicated

parts of the unification process will be determining the real vale of

state-owned enterprises, and adjusting accounting systems," wrote CBS

correspondent Portia Siegelbaum in October.



•Of those nearly 3,000 companies, the Cuban leadership has identified

941 as "highly vulnerable," due to corruption. The meat and dairy, food

production and construction materials industries, as well as

warehousing, transport and restaurants are among the worst, labor union

leader Ulises Guilarte said in April. Guilarte is among many other

officials and economists insisting on the crucial importance of

establishing wholesale markets, to provide the growing "non-state"

sector and reduce corruption. Even so, proposals by Brazilian and

Chinese companies to establish such outlets are still waiting for an

official response.



•The Cuban leadership recognizes the need for increased productivity, in

order to obtain higher salaries and a robust economy. But productivity

gains are not conceivable within the context of the 3,000 problematic

companies. Such gains are limited today to fewer than 1,000 entities,

most of them state companies associated with foreign investors, or

private players and cooperatives in agriculture.



•Solutions? The Lineamientos of 2011 are very clear: Entities who do not

meet standards will be closed down. If leaders don't want to appear too

drastic, they can organize fire sales, turn state companies into

cooperatives, or break them down into small entities. There is a

precedent for that: Twelve years ago, the government did just that with

three-quarters of the country's sugar mills.



•Ending the dual currency system is not just an issue of establishing

financial mechanisms. Without tackling dysfunction at state companies,

those financial mechanisms will remain extremely vulnerable. This is the

Black Hole of Cuban economics; it's not a monetary issue, it's

structural. Monetary expert Pavel Vidal put his finger on this when he

told IPS correspondent Patricia Grogg in October that "the dual currency

system is not responsible for the low purchasing power of wages or for

inequality … These are both structural, not monetary problems."



The second context to discuss are the dynamics of reforms toward a mixed

economy. Some angles that could make the unification more effective,

faster, and less traumatic deserve special attention.



•Microfinance and bank credit have begun to reach small businesses,

private farmers, and urban and agricultural cooperatives. But the

numbers — less than $100 million for some 300,000 customers — are

modest, and most of the loans go to non-productive purposes (home

construction and improvements, and some services).



•Small and midsize companies, both privately owned and cooperative,

should not be excluded from interacting with foreign investors, and

should enjoy direct access to imports and exports. The same is valid for

state companies. Union leader Guilarte gave an example of the absurdity

of the current restrictions: An executive for a state company may need a

$50,000 hard-currency loan to buy a machine that produces crackers for

the tourist industry. But she can't go directly to a Cuban bank, and the

application process gets stuck in ministerial red tape. Meanwhile,

hotels are spending $1 million to import crackers.



•The redesign of agriculture, although it has advanced considerably, is

still hampered by the survival of old policies — particularly the

mechanism of acopio, the forced procurement by a state distributor,

which poses obstacles to getting food to market. Another factor limiting

agricultural potential is farmers' lack of access to wholesale supplies

such as machinery, tools, fertilizer, and fuel.



•Other measures are still pending. They include salary reform (following

the lead of recent measures for doctors and athletes), taxation, price

reform, accounting, and more. Taxes must provide a consistent incentive

for private businesses, and not just favor cooperatives and foreign

investors. Agriculture took that step recently, when the government

corrected the exclusion of private farmers from tax incentives.



•The reformers have some successes to show since 2007. Chief among them:

"The deficit on current accounts of the balance of payments was reduced,

the fiscal deficit has shrunk to approximately 3% of GDP, and the

banking crisis was solved," Vidal and Everleny said in their Brookings

presentation. Also, they add, inflation today is lower than in the 1990s.



•Reforms in the external sector, such as the new migration law,

legislation for the Mariel Special Development Zone (ZEDM), and the new

foreign investment law, are bound to play a positive role. Although it's

too early to determine how successful they are, they sure help the

currency merger process.



•Also, Cuba has been successful in renegotiating its heavy external debt

with its biggest creditors, such as Russia and Japan, as well as with

other countries (including an important rescheduling with China).

Démarches are underway with the Paris Club of lender nations, exploring

ways to trade debt for investments. The temporary freezing of

hard-currency accounts in Cuban banks, to face the impact of the 2008-09

world recession, is over and compensated. For the first time in 55

years, Cuba's hard-currency reserves are modestly increasing, allowing

steps such as the cash buy-out of Italy's STET, allowing the government

to take full control of state telecom ETECSA. The deal was in accordance

with international standards and satisfactory for the Italian partners,

thus setting a positive precedent for future investors.



•But huge imbalances between growing imports and limited exports

persist. Trade with Brazil totals nearly $700 million, $600 million of

which are Brazilian exports. Trade imbalances of that kind will

undermine any currency adopted by Cuba.



Many experts and observers compare Cuba to the Chinese experience. But

there are two differences. One, China operates in an entirely different

historical context. Two, China had a two-currency system from 1978 to

1994 with a highly divergent system of exchange rates.



Within this time frame, the Chinese conducted their reform process

through two stages, 1978-1984 and 1984-1993. During the first period,

three main transformations took place: Privatization of agriculture,

opening to foreign direct investment (in part through special

development zones), and the promotion of private startups. During the

second period, a wave of privatization of once state-controlled

industries swept over the economy, prices were liberalized, and state

companies were limited to key monopolies, all under a dual exchange rate

system. By 2005, 70% of China's GDP was generated by the private sector.

It was only then that China started its currency unification process —

at the culmination of its reforms, along with extraordinary two-digit

economic growth.



Cuba, in contrast, starts its currency merger when its reform process is

hardly beginning. The Cuban experience will have to develop along three

parallel lines:



a. Doing away with dysfunctional and outdated institutions, policies and

mechanisms from the 1980s and 1990s;



b. move forward with the implementation of the reforms already adopted,

and begin with the many others that are still pending; and



c. the currency unification, which will act as an effective detonator to

push forward a. and b.



This is the reason why ending the dual-currency system will not come out

of the blue, overnight, in one single piece of legislation to be

enforced on a 'Day Zero', as suggested by some journalists. Nor can it

take place in the course of 2014 by way of "carefully orchestrated

quarters, as consultant Emilio Morales suggested in a November study.

BBC reports indicating an 18-month implementation are not realistic at

all. Exchange trade analyst Tom Cleveland made a better assessment on

these pages in 2012 when predicting that "the dual-currency system will

take years to resolve."

The complexities are too many to be met with short-term solutions. But

the process cannot wait any longer. As pointed out by Vidal and

Everleny, "Unfortunately, the nation will have to face this complex

process of monetary unification without the assistance of international

financial institutions, with very limited international reserves, and at

a time of low economic growth. Nevertheless, we cannot go on waiting for

'the ideal moment' to implement it; the structural reforms are in need

of the monetary reform."



This is the reason why important economists, such as Vidal, Everleny,

Brunat, Morales and others, support the notion of gradualism. Cuban

leaders have insisted on a similar gradual pace, and the process has

already begun, "Cuban style" — experimenting with pilot projects in

limited areas, assessing results, making corrections, and moving ahead

slower or faster, depending on results.



A few examples for that pattern in currency reform:



•Free-market sales by private farmers and cooperatives to hotels and

restaurants are already operating with an exchange rate that began at 7

Cuban pesos (CUP) per U.S. dollar, but was then lowered to 10:1.



•A host of state companies — regardless of their subordination to a

ministry and independently from them — are conducting their transactions

with other state entities and the Central Bank based on an exchange rate

of 10 CUP: US$1 or 5:1.



•The sugar industry is currently working with three rates: 12:1 in

exports, 7:1 in imports, and 4:1 in oil purchases from Venezuela.



•Transport cooperatives are working with an exchange rate of 10:1.



•In determining salaries, the experiences of workers at the ZEDM, as

well as that of sports professionals and public health personnel are

providing hints about the policies to be put in place.



•Opening hard-currency stores to the CUP is another important signal.

The case of two important stores in Havana — La Copa and La Puntilla now

accepting both CUC and CUP — is a clear indication of the gradualism of

the currency merger process.



World Finance, in a January article, extends the benefit of the doubt to

the Cuban approach: "The complete unification of the two currencies is

many months, maybe years, away from being fully achieved, bit it could

well be the policy that defines Raúl Castro's legacy as the reformer of

Cuba … by promoting prudent and timely reforms — which Fidel was

reluctant to do. The younger brother will have carved an even bigger

name for himself in modern Cuban history."



Other steps and actions have not yet surfaced. For Vidal and Everleny

and many other experts, devaluation — the backbone of the unification

process — entails risks and complications. How will the devaluation

policies be implemented? How will the balances of CUP, CUC and

foreign-currency bank accounts be affected? How will this affect foreign

investors and their accounts?



Tensions

In opposition to a gradual process, there are experts and observers who

suggest as inevitable the adoption of "shock therapy" policies, in which

— as argued by International Monetary Fund expert Rafael Romeu — "many

social services would have to be eliminated."



Another concern is inflation. "Any increase in the value of the unified

peso would increase (Cubans') spending power. This could stoke inflation

and lead to widespread shortages. The concomitant fall in the value of

the CUC, meanwhile, could be fiercely resisted by those with savings in

the harder currency." Expert Tom Cleveland laid out a similar scenario a

year earlier: "If the 24:1 ratio were changed immediately to parity, the

demand for CUC-priced goods would skyrocket and inflation would send all

prices soaring. Dissolving the old dual-currency system is not easy."



Despite such apocalyptical vision, whatever the policies the Cuban

leadership will follow, there are certain pillars of the Cuban model

that will not be jeopardized or even questioned:



a. The notion of "shock therapy" or "big bang" is not an option;



b. no more egalitarian practices or designs;



c. no one will suffer destitution; and



d. the most important social programs will not be eliminated.



Even those who suggest shock therapy are very cautious. Emilio Morales,

who is not precisely on friendly terms with the Cuban government,

stresses that "shifting to a single currency cannot turn into a sort of

'shock therapy if political suicide is to be avoided."



Vidal and Everleny point out that "compensatory measures will be

required for state businesses and families affected." They also stress

that "economic authorities will have to avoid an inflationary spiral" by

subsidizing retail markets.



The Cuban leadership and the economic team are very much aware of the

costs and benefits of every single step of the process. They have

studied carefully, in Cuba and China, the Chinese experience to see

whatever may be valid for Cuba.



None of the authors mentioned in this paper have made any reference to

the many IMF-sponsored monumental disasters in implementing monetary

recipes and new-currency experiments — such as the Plan Austral in

Argentina and Plan Cruzado in Brazil, both triggering hyperinflation —

and what lessons to draw from them. There is also the infamous Caracazo

of 1989, resulting from a package recommended by the IMF, where

hundreds, possibly thousands, were killed by state security and the

military.



Are we to ignore such experiences? Is someone wishing for a similar

outcome in Cuba? Is the Cuban leadership is unaware of these traumatic

experiences? Quite the contrary, those experiences have been studied in

great detail in Cuba, and everyone is well aware of their results. It

would be foolish to think that the Cuban leadership is not fully aware

of the complexities and risks of ending the dual currency system.



In conclusion, some key ideas regarding government policies:



•The unification process is already beginning to unfold, step by step,

following a pattern of gradualism.



•The crucial stages are not to take place anytime soon — this year, 18

months from now, not even by 2016. By 2018, completion of the

convergence of the two currencies may be a more tangible reality.



•The four pillars (no shock therapy, no egalitarianism, no destitute, no

end to crucial social programs) and the three lines (do away with

economic legacies, push forward and expand the reform, and currency

unification) will be the guiding principles and strategies of the Cuban

leadership.



A highly qualified expert on Cuban affairs, Julia Sweig of the

Washington-based Council on Foreign Relations, has this to say: "The

dual currency has for years hovered over the reform process — a symbol

of inequality and an obstacle to an efficient, productive economy. Raúl

Castro first surfaced the need of unifying the currency when he took

office. I'm betting by the time he steps down in 2018, if not before,

and despite the vagueness of the official language, Cuba will have a

single currency."



Former Cuban intelligence officer Domingo Amuchastegui has lived in

Miami since 1994. He writes regularly for Cuba Standard and CubaNews on

the Communist Party, Cuba's internal politics, economic reform, and

South Florida's Cuban community.



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