Inflation still out of control in Cuba
The updated official data on the Consumer Price Index (CPI) indicates that inflation in Cuba did not stop in 2021, but continues in 2022, although it is losing some momentum. This confirms that there are other factors, beyond the monetary reform, that continue to fuel the inflationary process.
The slow recovery of tourism and the economy in general, the permanent scarcity of goods and foreign exchange, the fiscal deficit and its financing through monetary issuance, the parallel exchange rate, would be among the main factors to consider.
Inflation has eaten away at the real value of savings in pesos and has nullified the nominal increase in wages and pensions that was implemented last year. It is another of the many obstacles that the nascent micro, small and medium-sized private enterprises must face. It also increases inequalities.
Families with access to remittances, foreign exchange, or the ability to invest in businesses that benefit from rising prices can find ways to hedge the costs of inflation, even if only partially. But the majority of the population with fixed salaries and pensions in pesos has no escape from the reality of seeing how the purchasing power of their income deteriorates a little more every month.
The lack of control of prices adds uncertainty and mistrust about the future of the economy, fosters pessimism and social discontent. The July 11, 2021, (11J) protests and the current migratory wave are no strangers to it.
There are several challenges and conflicts of objectives that the Cuban government must face. It is not an easy task to manage economic policy when domestic and international inflation are combined with the drastic fall in exports and GDP in an economy that has already exhausted its fiscal policy spaces and has very limited access to international financing.
Added to this are the incomplete reforms of a failed economic model, the escalation of sanctions under the last two U.S. administrations, and the impacts and ramifications of the war in Ukraine.
The official inflation data
The inflationary process has eaten away at the real value of savings in pesos and nullified the nominal increase in salaries and pensions implemented in 2021. The latest data published by the National Statistics Office (ONEI) for the CPI for February of this year show a year-on-year inflation rate of 23%. That is, compared to February 2021, the current average price levels are 23% higher, according to official records. This is a high inflation, but lower than the 77.3% recorded for the entire year of 2021, in the midst of the so-called monetary order and the devaluation of the official and parallel exchange rates.
Data for February 2022 reveal that price increases in the Transportation, Restaurants and Hotels, and Food and Non-Alcoholic Beverages categories explained most of the month’s inflation.
The ONEI report explains that when it comes to food, dairy products experienced the greatest increases: processed cheese, liquid milk, white cheese, and powdered milk. Inflation for the month alone (compared to January of this year) was 0.9%, higher than the 0.15% inflation reported by ONEI for January.
Since 2020, the official data already showed an increase in inflation, with a rate of 18.5%, which marked a turning point compared to the previous decade, in which annual inflation had averaged 1.3% thanks to the control of the fiscal deficit and wages, and fixed exchange rates for the Cuban peso and the Cuban convertible peso.
Looking at the monthly trajectory of the CPI, in January 2021 the main jump in the official CPI took place from 109.5 to 157.8, that is, 44% (due to the direct initial impact of the monetary reform and the devaluation of the peso). Then, the trajectory of the CPI flattened until September, but in the last quarter of 2021 it picked up again. In September the IPC stood at 174.8 and in December at 194.2.
In other words, the last quarter of 2021 added 11% to inflation for the year. This, added to the data for the first two months of 2022, reveals that price dynamics remain out of control, even in the official CPI statistics.
Although the official data recognizes a drastic increase in inflation, it should be taken into account that they are underestimating its true value by several points, because the CPI is considering a structure of household expenses that is extremely outdated (from 2010) that does not correspond to the true weight of private and informal markets in the household consumption basket.
Other estimates place inflation at around 500%, which indicates that average price levels grew around 6 times in 2021. Official data does not even recognize that prices doubled in 2021, which does not coincide with the reality that families are facing in consumer markets.
Absence of a macroeconomic stabilization plan
Inflation represents a new challenge for the Cuban economic authorities. This implies that the Cuban government will have to continue to focus on solving the structural and institutional problems of the economic model, but it will also have to pay special attention to the macroeconomic imbalances that cause the persistence of inflation.
For President Miguel Díaz-Canel’s agenda, it should be just as important to continue with the pending structural reforms as it is to launch a macroeconomic stabilization plan.
However, in the latest pronouncements by Minister of the Economy Alejandro Gil in February, there are no signs that the government has defined such a macroeconomic stabilization plan.
The government’s hope is that inflation will adjust on the supply side: more production and more dollars entering the economy. This is clearly a fundamental component to control inflation, but it is not the only one. Another fundamental element is the high fiscal deficit and its monetization with the printing of more pesos from the Central Bank.
However, the declarations of Minister Gil have not been very forceful in the need to put a stop to these fiscal imbalances.
The strategy of hoping that the recovery of the economy will be enough to stop inflation seems risky. It is important to recognize that inflation has several culprits and that, therefore, there are several measures that must be considered to control it.
The longer this entire episode of monetary instability is present, the more difficult and costly disinflation is and the more damage it will do to the economy.
Supposedly anti-inflationary measures
The Ministry of Finance and Prices (MFP) issued Resolution 105 in April 2021, a supposedly anti-inflationary measure. Resolution 105 tries to cut the transmission channel of international inflation and the increase in import bills towards retail prices faced by consumers.
The MFP defined a base price (it is not explained how they calculated it) for imports of rice, beans, wheat, oil, milk, and chicken, and established that the State budget subsidizes state wholesale companies if there is an increase above 4% of the base price.
Other similar decisions were made in 2021 to try to curb inflation using fiscal spending. On several occasions, the Minister of Finance, Meisi Bolaños, went on television to the Round Table program and promised more subsidies, tax cuts, reduction in energy prices and more support for families and economic sectors.
In principle, it may make sense not to want to add more gasoline to inflation, since it is one of the problems that most overwhelms the population. The MFP is trying to protect the value that consumers will pay for essential products in the food basket. However, public spending policy long ago exhausted its possibilities of influencing the economy without generating more inflation; exactly what they want to avoid.
The latest data from the ONEI show that the fiscal deficit was 17.7% of GDP in 2020 and it is likely that it will have exceeded 20% in 2021. Before that, there were already five consecutive years with a fiscal deficit that fluctuated between 6% and 8% of GDP, which served to cushion the impact of the Venezuelan crisis and the escalation of U.S. sanctions under the Donald Trump administration (2017-January 2021).
Under these conditions, when the Ministry of Finance promises more subsidies it only adds more points to the inflation rate. The state budget long ago crossed the threshold beyond which it can no longer increase public spending in real terms. The announcements of tax aid and increases in subsidies mean an increase in the inflationary tax that families are paying. If resolution 105 achieves anything, it is, perhaps, managing the distribution of the cost of inflation, but without avoiding it.
With resolution 105, and other subsidies that have been applied, the government avoids inflation in the state markets and in more sensitive products for the most vulnerable groups, but the fiscal deficit and the indiscriminate printing of Cuban pesos continues to increase, which ends up being reflected in a short time in more inflation in the private and informal markets.
It is also a decision with a political economic background, because later the government will blame private parties and speculators because they raise and manipulate prices, while the State keeps prices invariable and defines subsidies to protect the population without saying that it is the government itself. In other words, it is the State that continues to foster the imbalances that ultimately drive inflation.
The role of exchange rate policy
The social networks are demanding that the Cuban government implement actions to put a stop to the depreciation of the exchange rate in the informal market, which exceeded the barrier of 100 Cuban pesos for both the euro, the physical dollar and the bank dollar (MLC). However, Minister Gil ruled that out for now although some action of this type is being considered to influence this market.
Admittedly, proposals that the government sell dollars to stop the informal depreciation of the exchange rate do not seem feasible or effective. First, the government doesn’t even have those dollars to buy medicine and food. But if it did, international evidence has shown how difficult it is for central banks to go against a trend in the foreign exchange market, especially when it comes to avoiding depreciation of the national currency.
A different thing is the sale of the dollars that the exchange houses (Cadeca) and the banks buy, a practice that could be resumed as soon tourism and remittances start recovering. The purchase and sale of foreign currency in exchange houses and in banks (without the intervention of the central bank, that is, without putting in dollars from international reserves) is essential to formalize this market and provide households and the private sector with a service necessary for its operation. The formalization of the foreign exchange market is a crucial measure to control inflation.
However, the million dollar question is whether this service can be resumed with the fixed exchange rate of 24 pesos per dollar, or will it be necessary to proceed with another devaluation of the official exchange rate. It should also be assessed whether it would not be advisable for the Cadecas to operate with an exchange rate that, without being floating (without changing every day), can have periodic updates to approach and take into account the values of the informal market, as the exchange rate worked in this market from 1995 to 2001.
In other words, there is a precedent that the government could use as reference. Another more radical option is to move to a flexible flotation system. It would require working on several aspects to guarantee its operation, an option that Minister Gil has ruled out for now.
An issue to be considered by the Central Bank is whether it is going to reorganize an exchange regime for exchange houses and bank operations with the population that is different from the exchange regime for companies, or if it is going to try to maintain the unification of the official exchange rate that was achieved with the monetary ordering task.
Any decision that will give more flexibility to the exchange rate of the exchange houses, keeping the official rate unified, implies that state companies and mixed companies will have to get used to working with a variable value for the Cuban peso; something that would be completely new in the context of the Cuban economy.
Another thing that the Central Bank could do from monetary policy would be associated with managing interest rates. This is the monetary instrument most used by central banks in the world, but that has not been used by the Cuban monetary authority. While a substantial recovery of economic activity is achieved that guarantees a greater demand for Cuban pesos from the real economy, the Central Bank could encourage the holding and purchase of Cuban pesos from a financial instrument with attractive interest rates.
They can be the fixed-term deposits of the banking system or the public bonds of the Ministry of Finance and Prices, or some bonds of the Central Bank. A few quarters ago, the government spoke of selling bonds to the population, but it is an issue that has remained silent.
In any case, it is clear that the monetary reform is still incomplete. There are several issues on which decisions must be made to truly achieve a unified and functional monetary and exchange system for all economic actors. And none of this is possible while inflation is out of control.
