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A Triumph of Intelligence: Cuba Moves towards Exchange Rate Unification

The “Official Note” was written in a characteristically defensive style, with stern warnings that the strategy will exclude the use of “shock therapies”. But never mind. The important message was clear: Cuba is going to implement “a timeline for measures which will lead to monetary and currency exchange unification.” The inefficient, absurd and discriminatory multiple exchange rate system is on its way out, and the remaining question is how and when.[1]

Farewell to duality

It is often asserted that the essence of the present system is the existence of two currencies: the inconvertible CUP and the convertible CUC. This misses the point. To be sure, there are domestic and foreign holders of CUC deposits, and something will have to be done at some point to remove that currency form circulation in a fair way (more on that below). But from an analytical standpoint the CUC is a sideshow that can be largely ignored. The Cuban government’s plan apparently focuses on making the CUP the centerpiece of the reform, and this is entirely appropriate.

At present, the most serious and harmful duality is not between CUC and CUP, but between two types of CUPs: that applies to households (24-25 CUPs per US dollar[2]); and the one that applies to enterprises (1 CUP per US dollar).[3] This duality was introduced in 1995 and rubber-stamped the huge depreciation of the peso that had occurred in the parallel market in the early 1990s. Apparently there were no fatalities. Since then households have been able to buy and sell dollars legally in exchange houses named CADECAs. Enterprises, however, continued to buy and sell dollars at par, giving rise to a huge gap between the two official CUP exchange rates. The system involves a huge discrimination against exporting firms and a huge subsidy to importers.

Another aspect of the existing multiple rate system is that it raises revenue for the government. Workers in the tourist industry and Cuban professionals working in Venezuela, Bolivia and other places earn dollars, but the Cuban government takes a cut and pays the workers in CUPs.  thus imposing a huge tax. In addition there is a 10% tax on conversions of CUPs into U.S. dollars. Presumably these sources of revenue will disappear with unification and alternative sources will have to be found.

How to get from A to Z

In by far the most competent and informative piece written since Granma’s announcement, Pavel Vidal[4] explained that the authorities are likely to pursue a gradual and sectorial strategy. Gradual is self-explanatory: this will not be a Polish or Vietnamese-type of operation. Sectorial means that reforms of an experimental nature will be introduced at differential speeds in various sectors of the economy. For example, the value of the CUP for transactions between state hotels and restaurants and agricultural cooperatives was devalued from 1 CUP per US$ to 7 CUPs/US$ in 2011, and to 10 CUPs per US$ in 2013. (See the following Table, which summarizes several of the experimental changes that have occurred in recent years). Some of these changes are encouraging. It is heartening to see the tourism and the sugar sector among those sectors that start to benefit from a more favorable exchange rate. Most importantly, the process is already on its way.

Source: Based on information provided by Pavel Vidal Alejandro (op. cit.)

Source: Based on information provided by Pavel Vidal Alejandro (op. cit.)

Critique of the gradualist/sectorial approach

A critique of gradualism should not be based on ideology. It is a serious, practical issue and should be approached accordingly. In that spirit, I see two main problems with the approach that is being pursued.

  1. The first is that gradualism gives time to those who oppose the reforms to counter-attack. The authorities must be aware of this, and hopefully will not allow it to happen. Gradualism also maintains the distortions associated with the present system, possibly for a long time. In this respect, the notion that the full implementation of exchange reform will have to await a rise in productivity is worrisome: productivity growth has to be triggered by reform, including notably exchange rate reform.[5] The only valid argument in favor of gradualism is that the move toward a proper conversion factor for official economic statistics will require careful preparation and training.

  2. The second problem has to do with speculation. Having announced the plan, the authorities have given a clear signal that, in the end, the CUP applicable to enterprises will be devalued massively. Therefore, a fortune could be made by buying dollars for CUPs at 1:1 (for example by over-invoicing imports) and holding these dollars abroad (or at home under the pillow) awaiting the time when they could be sold at around CUP25 per dollar. Another mechanism would be to withdraw CUP deposits from Cuban banks, seek ways to exchange them for dollars at par (alleging the need for an enterprise to pay suppliers in dollars), and keep the proceeds abroad until the expected depreciation of the CUP is complete.

This critique could be countered in a number of ways. First, the incentive for arbitrage between the household-CUP and the enterprise-CUP has been available for years.  And yet arbitrage does not seem to have occurred, at least not on a large scale. This may be because arbitrage is prohibited, but the longer the incentive is in place the more difficult it will be to avoid the temptation to take advantage of the existing large exchange rate gap. Second, it may be argued that, at least through 2011, CUP-denominated bank deposits have not shown any sign of weakening. This is true, and we await anxiously the annual report to be issued by the Oficina National de Estadística e Información to see what happened in 2012. It could also be pointed out that Cuban banks offer dollar-denominated deposits: if you want to hold dollars, that’s one way to do it legally. Yes, but as they say in Mexico, the only true dollar is the “verde” (“green”). Residency matters in these things.

Some unsolicited advice

The gradualist-sectorial approach to exchange rate unification has some merits, but in my view these are offset by these dangers. My preference therefore would be to go as soon as possible for the Vietnamese type of solution—in other word to cut the cat’s tail (since it must be cut) in one installment. This would avoid all the risk of speculation associated with gradualism and yield the benefits of improved resource allocation, export performance and external sustainability at an early stage. It could be argued that, given the magnitude of the difference between household-CUPs and enterprise-CUPs, an immediate move would cause a traumatic shock to the economy. That is not very convincing. After all the equally huge officialdepreciation of the household-peso in 1995 went rather smoothly and did not produce any visible dislocations. ­­­­­­

Advice on economic policy should always be tempered by the recognition that the authorities are in possession of all the existing information and are in a position to evaluate the risks of alternative policies, notably as regards capital flight. But their decision should be based on practical considerations and not on ideological prejudice. If the current gradualist/sectorial approach is to continue, it will be important not to fall asleep and to advance as rapidly as possible both over time and across sectors. As a second best, the ongoing sectorial depreciation of the enterprise-CUP should be accelerated and extended to other sectors, particularly on the export side.

Other initiatives are worth considering. For example the value of the “convertible” CUC could be allowed to float temporarily and, at some point, investors could be required to exchange their CUC holdings at the going, market-determined rate, following a well-publicized information campaign. Since hopefully the value of the CUP will eventually be determined by market forces, rather than by fiat, EARLY experimentation with markets might also be helpful. For example, authorization could be given to CADECAs (and at eventually banks) to allow the household-CUP to move within a pre-specified band that might be expanded over time. This would create a proto-foreign exchange market in which the Central Bank of Cuba could conduct  hard currency auctions, thus allowing participants to gain experience and  provide an indication of the rate at which the enterprise-CUP should be expected to converge.


[1] “Official Note”, Granma International, (November 2013)

[2] These refer to buying and selling rates.

[3] See Hernández-Catá, Ernesto. “Macroeconomic Policy in Cuba. History, Problems and the Agenda for the Future.” Forthcoming in Bryan Christiansen, editor, Economic Growth and Technological Change in Latin America. London: 2014.

[4] Vidal Alejandro, Pavel. “Analysis: Cuba hints at how it will end the dual currency system.” CubaSTANDARD.COM (October 2013)

[5] The statement in the “Official Note” that subsidized retail prices for “people in need” will continue is also of concern. Logic and fairness (not ideology) requires that these subsidies and the associated price controls be eliminated and replaced by targeted fiscal transfers, at no cost to those in need.

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