The Cuban recession and the debut of public bonds

CALI, COLOMBIA — The macroeconomic data released at year’s end by the Cuban government confirm the projections that Cuba will enter a recession as a result of the Venezuelan shock.

The production of goods and services in 2016 fell by 0.9 percent. This is the first economic recession since 1993, when the gross domestic product (GDP) sank by 15 percent after the disappearance of the Soviet Union.

Since late 2014, after the dramatic drop in the price of oil and the resulting crisis in the Venezuelan economy, a recession in Cuba was highly probable, if we add a response by the Cuban economic policy that was insufficient for the magnitude of the approaching shock.

Relations with Venezuela are formed under very peculiar agreements between the two governments, with prices and financial conditions that depart from the more usual practices in international trade.

Therefore, it’s not a question of seeking new markets for the trade that can no longer be maintained with Venezuela; it has to be done in a different manner and propelling new economic sectors, given that it is quite unlikely that some other country will host Cuban doctors and sell us oil under the same conditions.

That’s why it was so important to begin as soon as possible a diversification of international relations and the liberalization of the domestic capabilities in search of an increase of productivity and greater efficiency in national production.

The attraction of foreign investment on a grand scale, the devaluation of the official rate of exchange and the monetary convergence, a deeper reform in state enterprise and the broadening of spaces for the private sector and cooperatives were some of the steps that seemed feasible and consistent with the reforms already begun.

Why weren’t all or some of these steps taken? Several explanations could be given.

Because there is no clarity or conviction on where to aim the Cuban economic model. Because the forces that resist changes have won the game for now. Because the needs of so many changes exceed the institutional and technical capacity to manage them all at the same time.

Because the U.S. embargo continues to impede the arrival of institutional foreign investors. Because some people really believe that a very slow reform and experimentation are the only effective way. And surely we could add other explanations.

Whatever the reason, the final result is that the reforms have slowed down instead of speeding up. After ten years, the results are not very encouraging, when one examines productivity, the average wages, or a specific sector such as agriculture.

The announcements of new transformations come at increasingly longer intervals. Cuba seems to live in a different dimension of time. It’s as if one year in Cuba is the equivalent of one month in the rest of the world.

However, the space in which the economy operates is not isolated. It competes with other destinations for international capital; it becomes technologically backward; it loses relative weight in the region, and suffers the cycles of international markets and the crises of its main economic allies.

The outlook for 2017 and the role of public bonds

For 2017, the government is planning an improvement in the state of the economy, something that is contrary to the projections we had made. The government is planning a 2 percent increase in the GDP.

This increase in the GDP for 2017 is based on two essential factors.

One, the hope that the Venezuelan economy will improve after the recent increases in the price per barrel of oil. Two, the Cuban government will enact an expansive and anticyclical fiscal policy.

In his speech to the National Assembly on Dec. 27, the minister of the Economy and Planning, Ricardo Cabrisas, stated that “the projections of the energy carriers for the coming year will permit to support levels similar to those of 2016.”

Very likely, this perspective has as a starting point the increase shown by the price of a barrel of crude over the past three quarters and some international projections that place it at higher levels in 2017. This favors the performance of the Venezuelan economy and opens the possibility that the shipments of oil to Cuba will stabilize, as well as the payments for Cuban medical services.

On the other hand, an increase in public spending and the fiscal deficit is projected to back the increase in the GDP. Fiscal spending is expected to increase by 11 percent, but this will not be covered by fiscal revenues, so there will be a “fiscal hole” of 11.5 billion pesos in 2017, i.e., an amount equivalent to 12 percent of the GDP.

In terms of percentage, this is the highest fiscal deficit since 1993; in terms of value, it more than doubles the deficit in 1993, which amounted to 5 billion pesos.

It is propitious that, after years of fiscal austerity, the government  decides to expand public spending to cushion the recessive effect of the Venezuelan crisis. It is valid to apply an expansive fiscal policy at a time when the GDP is dropping.

It is also wise to finance the fiscal deficit with an emission of public bonds, which will be bought by the Cuban state banks. This is a new instrument that the Ministry of Finance and Prices has been introducing for the past two years with a view to avoiding the monetization (printing of new money) as a mechanism to finance a fiscal deficit.

This mechanism of fiscal financing is close to international practice and its main advantage is that it avoids an increase in the primary quantity of money, thereby reducing inflationary pressures.

What are the risks in an expansive fiscal policy and an issue of bonds?

First, the fiscal deficit may grow in times of crisis but it should not do so excessively or remain high indefinitely. It’s okay to apply an anticyclical fiscal policy but having a “fiscal hole” of 12 percent of the GDP in 2017 raises doubts about the financial sustainability of the entire financing mechanism that is being put in practice.

As a point of comparison, it is expected that countries will maintain, over several years, an average fiscal deficit below 3 percent of GDP.

It should be taken into account that the foreign investors themselves, lenders and international providers will be the first to look at this indicator of fiscal balance. On an international level, this is one of the main indicators taken into account to evaluate the prudence in economic policy that defines the country’s financial risk.

Second, the issuance of public bonds reduces the inflationary effects but does not eliminate them altogether. To expand the fiscal spending by 11.5 billion pesos above the revenues can lead to an increase in prices, given the disproportionate expansion it creates in the demand for goods and services.

Third, Cuba does not have a fiscal rule that organizes and limits long-term fiscal balance (as other countries in the region have) but it relies on the government’s discretion every year. In other words, we don’t know what will happen with the fiscal deficits in the future.

We’re not certain that the bonds being issued and the bonds that will be issued in the future will be handled adequately, for the purpose of guaranteeing the sustainability of the entire mechanism.

It should be taken into account that the banks are using the savings of families to buy the public bonds; therefore, the government has a responsibility to obtain fiscal revenues in the future and balance the public accounts to meet its commitment to the banks and, eventually, to the bank savers.

To have an idea of the magnitude of the deficit and the resulting emission of public bonds, let us notice that in 2015 family savings in banks amounted to 23.68 billion Cuban pesos.

Therefore, the fiscal deficit budgeted for 2017 is the equivalent of 48 percent of the value of the savings accounts of families. Of course, the banks also have deposits from businesses and their own capital. Even so, this proportion of 48 percent draws attention because of the small amount of financing that the Ministry of Finance and Prices would have to deal with high fiscal deficits.

In summary, the projected growth of 2 percent for 2017 in the Cuban economy depends on a situation that continues to uncertain for the Venezuelan economy, despite the rise in oil prices. In addition, it is accompanied by an expansive fiscal policy that, if applied correctly, could help manage the crisis. If not, it would have disastrous consequences for the country’s monetary and financial stability.

The activation of an anticyclical fiscal policy and the emission of public bonds is correct, but a fiscal deficit that’s equivalent to 12 percent of the GDP and 48 percent of family savings in the banks seems exaggerated.

There would be no chance to repeat a fiscal expansion in 2018; rather, it will be necessary to make a fiscal adjustment to significantly reduce the deficit in the next several years.

Therefore, the government is gaining only one year, during which it will have apply some of the structural reforms that are still pending and are necessary to pull the economy fully out of the recession.

[The tourist boom, especially from the United States, such as those shown in photo at top sitting outside a restaurant on a street in Havana, has been insufficient to prevent Cuba’s fall into recession in 2016 (Photo by Jorge Luis Baños / IPS).]

Pavel Vidal is a professor at Javeriana University in Cali, Colombia. 

(Taken from IPS Cuba)