Cuban economist predicts ‘Day Zero’ for currency merger

Cuban economist predicts 'Day Zero' for currency merger

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."



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