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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