Handling the Dollar Crunch in Cuba
Luis R. Luis
Cuba suffers from a long-standing dollar liquidity crisis, a symptom of deep problems in the economy. Sadly the crisis does not appear to reach bottom. Indeed a mix of inadequate policies and adverse external events in the last three years has led to falling production and a critical shortage of foreign exchange needed to import foodstuffs, medicines, oil and essential farm and industrial inputs. In this note I take a look at recent data on Cuba’s external liquidity and sources of foreign exchange. A look at the Cuban government’s handling of the financial crisis follows.
An important way to gauge the tightness of a country’s external liquidity is its international reserve position. One also looks at the availability of foreign credit that will help a country get over a shortage of foreign exchange caused by cyclical factors or external shocks. These shocks are hitting developing countries which are struggling from the disruptive effects of the pandemic and the rising cost of foodstuffs.
Source: Bank for International Settlements, bis.org/locational statistics, 2022
Cuba does not publish data on its international reserve position. An alternative is data from the Bank for International Settlements on claims and liabilities of foreign banks vis a vis Cuba (BIS 2022). This data includes deposits and liabilities of Cuban banks (including the central bank) in banks of 48 countries and offshore financial centers. While Cuban banks hold accounts in Chinese institutions and in a number of countries in Latin America that do not report to the BIS, the BIS data is the best available indicator of the international liquidity of the Cuban financial system.
The red line on Chart 1 shows the net asset position of the Cuban banking system. During 2012- 2018 BIS data showed a net asset position oscillating between $1 billion and $2 billion meaning that Cuban deposits exceeded loans by that magnitude. To be sure with overall Cuban imports of $12.6 billion in 2018 net assets comprised a bit over one-month worth of imports and were precariously low. After 2018 the implosion of the Venezuelan economy and hardening U.S. sanctions led to further declines in the net asset position. The COVID pandemic and the collapse of tourism added more pressure and by the end of 2021 Cuba recorded a negative net asset position. This implies that net international reserves became negative as measured by net assets in international banks.
It is no coincidence that lending to Cuba by foreign banks also became negative in 2019-2021 after a period 2015-2018 when banks extended new credit to Cuba following restructuring of Paris Club debt in 2015. Thus in 2019-2021 Cuba made repayments to foreign banks as these failed to renew maturing loans to the island. Cuba’s weak credit position requires collateralization of many loans by bank deposits. Rebuilding Cuban banking assets is necessary both as a way to provide a liquidity cushion for Cuban import and foreign exchange operations and as a guarantee for the issuance of international letters of credit, loans and other financial instruments used in international trade.
Source: Derived by author from ONEI (2022). Assumes use of 180-day import credit lines.
China is a major source of import credits for Cuba. However, import data suggests that Cuba since 2017 has received no net credit from China (Chart 2). There are unconfirmed reports that Chinese official entities have restructured portions of Cuba’s debt. It is unclear if the restructuring involved some debt forgiveness as well as a rescheduling of maturities. In any case China has ceased to be a source of new import funding.
Official lending by national and multilateral agencies is an important source of financing for developing countries. Cuba’s lack of access to the main multilateral lenders, The World Bank, IMF and IBRD, is a major problem. While there is some bilateral financing available to Cuba, this is generally project-related and of limited assistance in a liquidity crisis. Net official lending from the main countries in the OECD (DAC countries) was practically zero, averaging $-6 million per year in 2017-2020 (OECD 2022). Likewise OECD countries cut official export financing to Cuba in 2017-2020 by an average of $-56 million per year. The main factor behind the credit contraction is payments arrears by Cuba on previous export credits or guarantees by official agencies.
What about the dollar/peso exchange rate as an indicator of liquidity? The black-market rate of the dollar in Cuba has tripled between the end of 2020 and July 2022 from about 35 pesos per dollar to over 110 pesos. This provides information about the dollar crunch and signals on-going excess demand for dollars. In the absence of government participation in the black market, it reflects private supply and demand for dollars and indicates a dollar shortage in the private sector. The weakness of the peso contributes as well to strong inflationary pressures in the island.
CUBA’S MYOPIC HANDLING OF THE DOLLAR CRUNCH
As is well known Cuba launched a monetary and exchange rate policy package at the end of 2020 known as “Ordenamiento Monetario” (Mesa Lago 2021). The package included monetary unification, a devaluation of the official rate of the peso and numerous changes to subsidies, wages, pensions and regulated prices in the state sector of the economy. The monetary reform aimed at implementing major changes in the financial and exchange rate system and contributing to the medium-term improvement of the external sector. The large devaluation of the peso and other measures were not however accompanied by a serious reform of the price system and a balanced fiscal policy which prevented stabilization of the economy. At the same time the government continues to face the dollar crunch mainly with short-term measures geared at keeping control of dollar flows while not addressing the deep problems in the economy which need a broad liberalization of prices and markets, opening of international trade, fiscal and domestic credit reforms.
Remittances from relatives living abroad is by some measures the most important source of dollar flows into the island. While these funds are sent to private citizens the government in contrast with other Latin American countries attempts to capture a substantial portion by means of schemes in government-controlled financial and retail firms. Chief among these is the forced requirement of hard-currency deposits for use in state dollar stores or MLC stores. This mechanism is accompanied by monopoly pricing of goods and results in a substantial loss of welfare for private citizens (Luis 2022A). Cuban residents pay high dollar prices for many essential goods that are only available in MLC stores. Like a tax the scheme discourages dollar flows through the formal financial system. On July 2022 the government lowered tariffs on goods brought by travelers which may lower demand for black market dollars to spend in MLC stores (Granma 2022).
A sizable source of revenue are medical services abroad. The main source of such income has been Venezuela, and this continues to this day as Cuba gets payment in-kind by way of petroleum products. The financial details of these bi-national transactions between Cuba and Venezuela are a state secret. The arrangement exposes Cuba to the risk of the Venezuelan government’s mismanagement of its oil sector. To be sure shipments to Cuba were cut in 2022 by roughly two-thirds from nearly 100,000 barrels per day in 2014 (Reuters 2022). Cuba exports medical services to some 60 nations, but most of these are unable to pay Cuba in hard-currency (Luis 2020).
Cuba’s attempt at capturing dollar flows by schemes directed at remittances and by what amounts to confiscatory taxation on medical doctors working abroad are deeply flawed. It limits the benefits of remittances to families and to the overall economy. Likewise the export of medical services is a tool of Cuba’s foreign policy which relies on the questionable use of medical professionals. Cuba would benefit more from medical and other professionals freely sending funds back to Cuba without the compulsory mechanisms presently in use.
Cuba’s low domestic savings and the dollar crunch mean that the island desperately needs foreign capital. Attracting foreign investment is very difficult because Cuba is a high-risk place to invest.
The Cuban government in recent years has announced changes in its foreign investment legislation, rules and bureaucratic procedures. Foreign investors can now have full ownership of operations without need of a joint venture with a local partner. Venues have opened for association with cooperatives and small firms while the government streamlines tax rules and tries to ease bureaucratic procedures. However the rules governing labor contracts remain onerous, and foreign trade and exchange operations are tightly controlled. The lack of an independent judiciary and the ample discretion of regulatory bodies compound risk. Cuba’s long history of default and payments arrears on external debt obligations render the island uncreditworthy. Lenders and investors face a high risk of non-payment of financial obligations.
The government has published data on approved foreign direct investment (FDI) contracts with no data on associated outlays (ONEI 2021). The minister of foreign trade mentioned that Cuba “attracted” foreign investments of $1.7 billion in 2019 and $1.9 billion in 2020 (Reuters 2020). These are commitments not disbursements. Commitments include domestically financed components and management contracts for hotels and other services not considered an inflow of FDI. Net FDI in Cuba from developed countries in the OECD averaged $27 million per year during 2018-2020 (OECD 2022). Based on OECD data net yearly investments from all countries averaged some $100 million in 2018-2020 compared to 2% of GDP or about $2 billion targeted by the government.
WAY OUT OF THE DOLLAR CRUNCH
The external payments crisis derives from deep problems in the economy (Hernández-Catá 2019). It cannot be solved without major policy changes. It may be eased temporarily because of favorable outside factors such as an inflow of tourists, a windfall from donor countries or a sharp fall in the price of essential imported goods. A lasting solution depends on launching adequate short-term and long-term policies that help manage the crisis and set course for improvements in productivity and international competitiveness. Government policies as mentioned above center on management dollar scarcity by the clumsy sequestering of dollar flows rather than having an effective strategy to improve the economy’s competitiveness.
There is a long list of needed reforms some of which have been discussed at meetings of ASCE and in this blog. These reforms crucially involve a decisive move towards a market economy with an important role for private actors and the opening of international trade and finance to private and state firms as well as individuals. Solid moves in this direction will lower the risk of lending and investing in Cuba by foreigners.
There is no evidence that the Cuban communist party is considering moving towards the broad liberalization needed to boost the productivity and growth of the economy. In this case management of dollar scarcity will remain centered on limited measures involving controls and distortions. A sad signal sent recently is the announcement of a new special exchange rate for some exporters, creating new distortions and the provision of incentives by administrative fiat rather than by market forces (Granma 2022).
Cuba’s external liquidity crisis continues as data shows net international bank assets became negative in 2021. At the same time commercial lenders and official institutions including Chinese entities are cutting credit lines to the island. The government attempts to manage the crisis by sequestering dollar flows from remittances and Cuban doctors rather than by effective measures that boost international competitiveness and make Cuba attractive to foreign capital. Cuba is a high-risk place for foreigners to lend and invest. There is no evidence that the Cuban communist party is ready to move towards a necessary broad liberalization of the economy.
BIS, 2022, Locational Statistics, bis.org
Granma, 2022, “Nuevas medidas que se ajustan a la realidad y al modelo socialista,” July 22.
Hernández-Catá, E., 2019, “The Misery of Cuban Merchandise Exports and the Sustainability of the Balance of Payments.” ascecuba.org/blog.
Luis, L., 2022A “Cuba: Dollarization and Devaluation,” Paper presented at the Annual Meeting of the Allied Social Sciences Association”, ASCE Session.
Luis, L., 2022B “Foreign Investment in Cuba: Risk, Uncertainty and Sanctions,” Paper to be presented at the 32nd Annual Meeting of ASCE.
Luis, L., 2020, “Cuba’s Uncertain Revenues from Medical Exports.” ascecuba.org/blog.
Mesa Lago, C., 2021, “La unificación monetaria y cambiaria en Cuba: normas, efectos, obstáculos y perspectivas, Documento de Trabajo. Real Instituto Elcano.
OECD, 2022, Geographical Distribution of Financial Flows to Developing Countries. www.oecd.org/dac.
ONEI, 2022, Anuario Estadistico de Cuba. Sector Externo. onei.gob.cu
ONEI, 2021, “Inversion Extranjera en Cuba. Indicadores Seleccionados.” Octubre. www. onei.gob.cu
Reuters, 2022, “Cuba struggles to buy fuel as imports from Venezuela dwindle,” April 5.
Reuters, 2020, “Cuba attracts $1.9 billion in foreign investment despite U.S. sanctions, December 8.