Cuba’s dual currency is due for revision

HAVANA — During the sessions of the National Assembly in December 2017, the Cuban government reprised the discussion about the importance of moving toward a new monetary and exchange system.

Among all the arguments presented, one of them had circulated previously through the academic media. While a majority of experts agrees that the road to a different system implies considerable economic and social costs, these should be judged in relation to the alternative option, i.e., to keep the existing scheme.

This scheme tends to hide or underestimate its costs, given that the Cuban model has “learned” to coexist with the deep distortions it generates, which are much more serious and complex than the daily inconvenience of making decisions about consumption, savings and investments on the basis of income and outgo in two currencies — three, if you include the American dollar.

The origin of the current scheme goes back to the early 1900s, in a scenario characterized by a deep economic crisis, major macroeconomic imbalances (depreciation, inflation, fiscal deficits) and the partial dollarization of the economy.

The use of a system based on two monetary signs (CUP and CUC), multiple rates of exchange (two at first: 1 CUP = 1 CUC = 1 dollar at the official rate; 25 CUP = 1 CUC at the current rate) and exchange controls (restrictions for companies and individuals as to the number of dollars they could buy at the existing rate, especially the business companies) isolated the “emerging sectors” (tourism, export, remittances) from the tottering of the segment that operated in pesos.

This was the key to instill confidence in the visitors and, above all, among potential foreign investors.

Temporary solutions for a permanent problem 

For 20 years, that original idea has assumed some additional characteristics, such as the incorporation of additional rates of exchange for specific sectors and operations. Besides, the convertible peso (CUC) has ceased to be fully convertible, both among the state-run businesses, thanks to the liquidity certificates, and the population, because of the recurring scarcity of goods and services that are traded with that currency.

The underlying aspect in both situations is an implicit and discretional devaluation of the CUC. Those adjustments were necessary because the original idea was conceived as a temporary solution, whereas the socioeconomic context has changed notably since those days.

While the Cuban scheme allowed the creation of minimal conditions to overcome the crisis of the 1990s, it created negative effects that have magnified with the passing of time.

The distortions are varied, but could be grouped in a few principal areas: the effects on the measurement of economic activity; the distortions on the assignation of resources (consumer goods, labor, capital) that are reflected in inefficient decisions in investment and consumption both for companies and persons (e.g., the implicit penalization of export companies); the segmentation of the domestic productive space, which reduces further the size of the internal market and the utilization of large-scale economies.

In terms of economic growth, transformation of the productive structure and social well-being, the cost is unmeasurable. However, the size of that challenge tends to push to the background some of the essences of the phenomenon and its consequences. Let’s see.

Foreign currency is chronically scarce 

The underlying problem in each international experience of this type lies in the balance of payments, i.e., at certain times a country is incapable of generating enough currency to pay its commitments in foreign currency, such as import costs, debt service (public and private), and repatriation of funds from foreign business producing in Cuba. The dividends due a foreign company that holds investments in Cuba must be repatriated in a foreign currency, never mind that those revenues were generated in convertible pesos (CUCs).

Within that logic, those adjustments try to solve a problem of assigning a scarce resource (foreign currency) that is not convenient to leave wholly in the hands of the market through an adjustment in the rate of exchange, in this case a depreciation. This clarification is needed to focus our attention on the fundamental problem, i.e., the chronic scarcity of “divisas” or foreign currency.

Unconventional monetary-exchange adjustments are not unique to Cuba, although their popularity has decreased in the past two decades because of their great economic and social cost and the improvements in macroeconomic trade in the majority of countries. Nevertheless, we’d have to make a distinction between two major motivations to adopt these schemes.

The most recurrent is a crisis in the balance of payments that a government decides to handle with caution to protect certain activities and the standard of living of its population. In these cases, the subjacent reasoning is that it’s a temporary Band-Aid that needs to be replaced by a more sustainable solution as fast as possible.

Other experiences tell us about a more prolonged use of “unconventional” schemes. That’s the case of some countries in Asia that grew rapidly, such as South Korea. The explicit objective was to create and use certain distortions (including manipulation of the rate of exchange) to benefit the export activities. Recently, a major debate has arisen over whether China maintains a depreciated yuan to give an advantage to its exporters in the international market.

When you begin to reason in these terms, you gain clarity with relation to the phenomenon itself and to the link that exists between a lasting and sustainable solution to the problem in the Cuban context and the structural reforms needed by the island’s economic model, some of them sketched as parts of “the updating of the model,” but poorly implemented in the past seven years.

Unleash our producers of exportable goods

This scheme was introduced in Cuba to deal with an extreme situation, but neither was it abandoned shortly thereafter nor the distortions were functional to a policy of activist development. Rather, the opposite was true.

Other aspects concur, such as the preference for the administrative and discretional methods that are consistent with the models of central planning (although the Cuban model has ceased to be one), and the resistance to introduce the changes that would make an alternative scheme viable, e.g., a change in the management of the state enterprises, the free acceptance of other producers of different forms of property, another mechanism of price formation, etc.

The limited reforms already introduced and the recent setbacks contain systemic contradictions that make it difficult to abandon the current system and limit the benefits of adopting a new scheme. In fact, some of the current approaches tend to reinforce the recurrent problems in the balance of payments.

Non-state sector in Cuba: Back to the past?

For example, promoting foreign investment in activities unrelated to exporting, or activities that don’t help reduce the effective costs of the exporters is the equivalent of incurring debt without the revenues that will service those commitments. To severely limit the use of Cuban factors because they invest in private enterprises and cooperatives makes the country more dependent on foreign resources.

The poor domestic economic performance pushes growing segments of its skilled workforce into activities of doubtful impact on the economy’s growth, while they create flows of foreign currency away from the balance of payments, toward the edge of “informal” activities. All this adds complexities to an acceptable solution.

It is urgent for Cuba to seriously tackle its scant foreign competitiveness, and it must make a decision on how to conduct its participation in the international financial fluxes. We shouldn’t think that we can unlink this matter from the structural weaknesses mentioned previously, or assume that a different arrangement will carry us automatically into prosperity. The systematic postponement of difficult decisions has brought us to this point, which is not a pleasant place.

If we have become accustomed to this bad “balance,” we’re on the wrong track and the debate about long-term development stops making much sense. One might hope than a major benefit of having a strong government, unattached to the interests of the national or foreign elites, would be the capability to make those difficult decisions that are in the best interests of the nation. Let’s wait and see.

Photo by: T.K. Hernández

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3 Responses to Cuba’s dual currency is due for revision

  1. Excellent article Professor Torres! I have long been an advocate of a single currency for Cuba, however I question the CURRENT feasibility of Cuba as an optimal currency region.
    I believe Cuba needs a greater degree of labor mobility, capital mobility, a more efficient free market mechanism for wage and price flexibility, a risk sharing system such as automatic transfer payments to help equilibrate the various business cycles into a more cohesive entity such that one side of the island is not in an expansion while the other half is in a contraction.

    One of my main concerns with the CUC is that it deflects demand for the local currency. I think this creates way too many distortions and undermines the confidence of international investors/foreign capital. I would much rather see all transactions and investments in Cuba denominated in the local currency. I think the move to a single currency would also improve the accuracy of the balance of payments accounts which would also promote a higher level of confidence among international capital.

    I think history has taught us that the Impossible Trinity/Trilemma is quite real and consequential; therefore I would not advocate for the Cuban macro- economy to attempt to test this jewel of international economics. However, I do think that some variation of the Trilemma should be aimed for if Cuba is to become an optimal currency area and an attractive destination for foreign capital and a welcomed participant in international finance.

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