2020 as prelude to monetary reform

The economic effects and consequences of the COVID-19 pandemic, which has caused death and suffering, is rivaled only by the negative impact it has caused to millions around the world. In Cuba, 2020 ended with a decrease of the Gross Domestic Product by around 11 percent, the steepest drop since 1991. The result obtained after a slight contraction of 0.2 percent in the fiscal year of 2019. Although the plans indicated a very modest expansion for 2020, the economic reality said otherwise.

Until February, tourist arrivals had fallen by 16 percent, while the harvest ended with a lower volume than the previous milling. Industrial production has been falling since 2016, in part as a result of reduced imports and energy austerity. Agriculture is facing a similar situation. The pandemic caused by SARS-COV-2 determines the magnitude of the crisis, but its manifestation responds to other conditions.

Starting in 2015, various problems manifested that negatively affected economic growth. On the one hand, the external environment has deteriorated significantly. The first factor is the pronounced Venezuelan economic decline. If the estimated goods and data for the exchange of services are included, Venezuela came to represent around two-thirds of total Cuban trade, a level of concentration that had not been reached since the late 1980s.

Likewise, a combination of unfavorable external situations, together with factors linked to the competitiveness of the Cuba destination, has caused a 20 percent reduction in tourist income between 2017 and 2019. Medical services have also been affected. New conditions demanded by the Jair Bolsonaro administration in Brazil motivated Island authorities to terminate their participation in the Mais Médicos program, which represented a yearly income of between 250 and 300 million dollars. Added to this was the cancellation of contracts in Bolivia and Ecuador.

Finally, the Trump administration has continued to apply sanctions on those activities that are decisive for the income provided by foreign currency, such as remittances, travel, the imposition of fines on financial entities linked to the Island and the reduction of flights.

[Editor’s Note: As we learned this week, the Trump administration has again placed Cuba on the State Sponsor of Terrorism List which gravely affects Cuba’s financial ties world-wide.]

Since 2016, deterioration of the external context has taken place during a long (and costly) pause in the process of “updating” the economy. In aspects as relevant as the promotion of cooperatives and self-employment, the wait was accompanied by a clear setback in the form of additional restrictions. In the summer of 2016, a package of austerity measures was adopted aimed at accommodating the appreciable decline in fuel shipments from Venezuela. That year, the government itself preliminarily announced a drop in GDP, although the final figures showed a meager 0.5 percent increase. In October 2019, the government could only pay a part of the corresponding renegotiated debt with the Paris Club countries. There was also commitments that have not been honored with foreign suppliers and companies operating on the island.

This time, the economic slowdown and the tightening of external financial conditions are accompanied by a deterioration in macroeconomic indicators, such as the fiscal deficit and cash in circulation as a proportion of current GDP. The evolution of these indicators shows us the enormous inflationary pressures expressed in the Cuban economy. Unfortunately, there are no instruments to manage them, except for administrative price controls, which only exacerbates shortages and the expansion of the black market.

In 2020, the disturbing lag in the decision-making mechanism was obvious. Only amid the extraordinary circumstances of 2020, a new initiative was adopted, the “Socioeconomic Strategy to Boost the Economy and Confront the Global Crisis Caused by COVID-19,” which includes several provisions already contained in the main political documents. Since then, the private sector has been authorized to carry out foreign trade operations; 15 measures were prepared for the state company; the commercialization of agricultural products was made more flexible thereby softening restrictions for the incorporation of new actors; and the currency reform was announced. All this, in a context in which dollarization spread, and shortages worsened.

Even so, what has been done falls short of the expectations and needs of an economy that for decades has been in urgent need of structural changes that will bring it out of a prolonged slumber. Other changes of greater significance, such as the flexibility of self-employment, the permission for the formation of private SMEs, or the deeper restructuring of the state-owned company remain stuck in technicalities and endless delays in the bureaucratic skein.

Under the worst imaginable circumstances it was decided to proceed with the monetary regulation, which is undoubtedly the most complex measure to date. The dominant view of the authorities is that it is an essential step to unlock other transformations. Contrary to what most experts have suggested, it will precede other structural reforms already mentioned that would have allowed the economy to develop more easily and have greater flexibility to overcome such an adverse environment.

The relaxation of private and cooperative activity is not the magic solution for all economic problems, nor is its defense an ideological whim of those who identify their need or worse — an alignment with “foreign agendas” designed to destroy the Cuban model. Under current conditions, this sector could offer two “updating” services that the state sector is unable to provide. In the first place, self-employment has shown that it can create productive employment at a much higher rate than the rest of the economy, which is especially important at a time of economic crisis and given the restructuring that the state-owned company and the rest of the public sector are undergoing. And it can do so for three main reasons: capital requirements per worker are generally lower than their larger, bureaucratic counterparts; it mobilizes internal and external savings from unconventional sources inaccessible to public units that are outside the government’s plans; they operate in sectors traditionally poorly served by state-owned companies, particularly personal and household services, where there is a great pent-up demand; and because they can benefit from highly flexible, informal supply networks with access to external markets through smuggling and individual importation. As if that were not enough, their small size is an element that allows them, on the one hand, to be more agile to react to changes in the environment, and on the other that their disappearance will not represent a systemic threat. This last aspect is frequently invoked to maintain unlimited support to state companies that are clearly unviable.

The second service that the private sector could offer to the ‘update’ process is that it can become a key instrument for improving macroeconomic indicators such as the fiscal deficit or inflation. Let’s see how it works. The creation of employment and the increase in the level of activity allows the payment of a higher volume of taxes, which contributes to increasing tax revenues. If these jobs allow more flexibility to the authorities in the restructuring of unviable state enterprises, this reduces the subsidies they receive, reducing budget expenses. This is especially true if jobs are created in such a volume that it also allows for a reduction in informality and an increase in the rate of economic activity. The mobilization of domestic savings that is outside the banking sector allows a productive use of these resources. In many cases, this makes it possible to reduce the demand for final goods and services, transfer consumption to the future, and create a supply linked to income in the present. In addition, greater competition in the circuits where it operates contributes to modulating prices, thus serving to combat inflation.

The above would have required some transformations that were put aside. Had they been implemented, and would have been given time to mature, macroeconomic conditions would be much more favorable to face the current monetary reform. But despite the fact that several years of work were carried out on the conformation of the proposal that is being implemented, some aspects that may undermine the main declared objectives, all of them very valid, attract attention. Among these elements are: the maintenance of the inconvertibility of the CUP when the goods and services that are traded in foreign currency expand; the scant attention paid to the existence of the informal foreign exchange market and its effects on price formation and inflation; the little importance given to the private sector in the fundamental axes of the proposal including the calculation of the Basket of Reference Goods and Services (CBSR), the CBSR itself is estimated establishing June 2019 as the reference period, while economic conditions have changed notably until the implementation date, including significant price variations, the period granted to state-owned companies to readjust to the new scenario — which is a non realistic one year — especially when investment resources are scarce and the economy recovers from a severe contraction.

Since the most important positive effects will take some time to materialize and depend on other accompanying measures, the volume of wealth in the initial moments does not vary. Thus, any gain in purchasing power for one group of the population will be marginal, and will occur at the expense of another. A change in the nominal (monetary) sphere cannot be expected on its own and to solve structural problems such as the “inverted pyramid” or disinterest in work instantaneously.

This year will undoubtedly be a period of definitions for Cuba’s economic reform. It may even take a little longer.