Monetary and Exchange Unification

by Mauricio De Miranda Parrondo*

For several days now, arguments about the need to proceed to monetary and exchange unification have started to appear in various Cuban news media outlets, with an emphasis on the negative consequences of having established a dual monetary system in the 1990s.

This is joined by unconfirmed rumors, which would indicate the possibility that in a short time the circulation of the Convertible Peso will be eliminated and that there will be a unification of prices in Cuban Pesos for goods and services offered by state-run commercial networks, as well as the creation of a new single exchange rate that would considerably devaluate the current official exchange rate of 1 USD = 1 CUP, which only works for state-run companies, but that, apparently, would revalue the also official current market rate of 1 USD = 24 and 25 CUP (depending on the exchange rate used when buying or selling foreign currency).

In addition to these rumors, there’s the existence of a supposedly new salary scale that would work for the state-run sector and that would multiply several times all the current salary levels (with nothing being said about the old retirement pensions).

What’s curious is that this would all happen a few months after the Cuban government decided to open retail stores which would sell a number of products considered “top of the range”, but which were later expanded to staple items, requiring the use of bank cards backed by deposits in US dollars or other Freely Convertible Currencies (FCC). This has brought about, in practice, a new segmentation of the market into products sold in foreign currencies and products sold in the national currencies and that, eventually, would be sold in a single one, as a result of the ‘unification’. In this scenario, it’s worth clarifying that as long as several currencies circulate in a market, even through the existence of instant access accounts, we’re not in the presence of real monetary unification.

One of the problems of the existing dual monetary system has been the multiple exchange rates, but especially the persistence, for 60 years, of a fixed exchange rate, artificially overvalued, for the Cuban Peso in relation to the US dollar, which does not reflect the real conditions of the national economy with regard to the international economy and which has seriously distorted competitiveness in the Cuban business sector.

A new exchange rate may be established, prices may be modified and salaries and pensions may be reformed, but that would only bring momentary order to the country’s monetary relations and its pricing and salary systems; it wouldn’t necessarily end the distortions of the Cuban economic system or specifically the ones in the monetary system.

The existence of a market, however limited, in which the Cuban Peso does not perform its functions as money will generate additional demand for foreign currencies in the informal market, generating options for extraordinary benefits for those who operate in that informal market. If, as it is customary, those economic actors are confronted with punitive measures, that would only manage to increase the gap between the exchange rates in the formal and informal markets. Therefore, it would be prudent to anticipate this type of scenario with the adoption of appropriate economic measures.

What would these measures be?

  1. It would be necessary to define what type of exchange system will be established. A currency board like the one that determined the equivalence of the Cuban Peso to the US dollar before 1959 or like the one that brought the creation of the so-called CUC? This would mean a nominal pegging of the peso to the dollar, in the defined amount, and the variation of the exchange rate with the other currencies, following the course of the dollar. This measure wouldn’t keep the country from facing an exchange crisis when a new crisis in the balance of payments occurs, which may be likely in the case of Cuba if structural problems aren’t solved, a greater rate of economic growth isn’t reached and a better international insertion of the economy isn’t achieved. A flexible exchange rate? It might turn out to be the most logical path so that the exchange rate would be the one to absorb external shocks and the macro-economic policy wouldn’t depend on the preservation of a set exchange equivalence. However, in this scenario, one would have to be prepared for a sustained depreciation of the Cuban Peso as conditions in the production of goods and services don’t improve, with the ensuing inflationary pressures.
  2. Reality indicates that the Cuban Peso and the Convertible Peso are overvalued, both in the exchange rate for the former and for the latter, which means that both are worth more than they should. The official exchange rate that companies work with is absurd and holds no relation to reality. The exchange rate of the CADECA (Cuban government-run bureaus de change), which has held stable for a long time, seems to show signs of overvaluation in light of the reappearance of an informal market with values that have recently been fluctuating between 1.30 and 1.80 CUC for 1 US dollar. This is the result of two concrete phenomena: a) the breaking of the ‘currency board’ that sustained the convertibility condition of the CUC in equivalence of 1 USD = 1 CUC, and by which CUCs would only be issued if there were USDs to back them and b) the reappearance of a market that only operates in FCC, which makes the demand for foreign currency rise considerably. The overvaluation of a national currency discourages exports because it makes them more expensive and stimulates imports because it relatively cheapens them. If there’s an administrative adoption of an initial exchange rate that doesn’t reflect the real conditions of the economy, the current distortions would be reproduced, because the exchange rate is the relative price which enables the connection of any country’s economy to the international economy. For that reason, instead of adopting administrative measures, it would be much better to bear in mind the signals being sent by the market. In that scenario, the CUP could be exchanged 25×1 with the current CUC for internal purposes, but the exchange rate between the USD and the CUP that’s initially established should consider those market signals and, therefore, be devaluated rather than revalued.
  3. For the Cuban Peso (CUP) to be really convertible, it must ensure its full internal convertibility, guaranteeing the adequate functioning of the exchange market and allowing the national currency to operate fully, with unlimited debt-clearing power and obligatory legal tender in the entire national territory, which brings into question the functioning of the new FCC stores, strongly criticized by the population with good reason.
  4. None of this makes sense if the necessary economic measures aren’t adopted in order to promote the production of goods and services. If measures aren’t adopted to increase the offer of goods and services, one runs the risk of an inflationary spiral that, should one try to prevent it artificially with rationing or capped prices, will manifest itself in the already known form of a ‘repressed inflation’, which is nothing else than shortages, long lines, and stimulation of the underground market. In these conditions, the most appropriate thing to do would be to eliminate all the restrictions that have prevented development in the production of goods and services by private and cooperative producers, along with the operational and financial autonomy of state-run companies. For that purpose, it’s indispensable to adopt the right sequence, and that means the first thing would be to eliminate the current restrictions to the functioning of private and cooperative small and medium-sized enterprises (SMEs), which, in an appropriate climate, could absorb the workforce that’s currently in excess in the state-run sector and could generate the goods and services that it’s shown itself unable to produce. To that end, it’s necessary to create an adequate institutional climate that will promote internal savings and investment, both foreign and domestic, without restrictions on the types of property. This should be joined by a modification of the recently adopted norms for regulating the participation of the private and cooperative sectors in foreign trade, which are, by any reckoning, inadequate.

The economic and political cost of continuing to disregard economic laws may be very serious for the country. Economic policy should be oriented toward the adoption of measures allowing an exit from the crisis and incorporation into a path of sustained growth with a positive effect on the levels of economic and social development, getting past ideological barriers derived from dogmatic conceptions.

*Cuban economist. Professor, Department of Economy, Pontifical Xavierian University in Cali, Colombia, with a doctorate in International Economy and Development by the Complutense University of Madrid.

Translated from the original