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Cuba hints at how it might end its dual-currency system.

The government of Raul Castro has done very little, until now, to eradicate the distorting effects of the parallel circulation of two national currencies--the Cuban Peso (CUP) and Convertible Peso (CUC)--and to correct the multiple exchange rates.

However, from 2011 to 2013 some decisions were taken that may provide hints about the kind of arrangements that could take shape in pursuit of a gradual elimination of the dual currencies and exchange rates.

Since 1993, the Cuban peso and the U.S. dollar have officially been circulating in the Cuban economy, side by side.

In 2003 and 2004, the government took a bundle of actions that brought about the substitution of the dollar's functions by a third currency: the CUC.

This brought us to the current situation, in which the economy stopped being dollarized, while maintaining the parallel circulation of the two currencies, both of which are issued by the Central Bank of Cuba.

In the 1990s, together with the double currency, an even more distorting factor was introduced: the duplication of exchange rates.

From 1990 to 1993, the exchange rate of the Cuban peso suffered an enormous depreciation vis-a-vis the dollar in the informal market.

This was accepted by the Cadeca government network of exchange houses, created in 1995 to effect operations with Cubans and tourists.

COMPLETE REFORM VS. REFORM BY SECTORS

However, the new value of the Cuban peso never reached the accounting and exchange operations of the business sector.

Institutions continued to operate with the official exchange rate of the 1980s--1 Cuban peso (CUP):US$1. Today, Cubans and tourists get 24 CUP for US$1 in Cuban exchange houses, but the official exchange rate used to calculate macro-economic performance and that of state companies continues to be 1:1.

Given this, the principal step the Central Bank of Cuba should take to eliminate the dual currency is the devaluation of the Cuban peso (CUP) in the business sector--an issue that has been proposed for more than 20 years. Once consensus was achieved about the need to do it gradually, the debate in Cuba about the best strategy to approach monetary reform has been moving between two lines:

1) Complete reform, consisting in the implementation of gradual devaluation in the CUP exchange rate for all companies; and 2) reform by sectors, consisting in the gradual incorporation of some sectors in a particular system with a devalued official exchange rate.

In other words, gradual change can be executed either over time or by sector, or with a combination of both. Some official declarations, as well as specific experiments that are already underway or taking shape, hint at a reform that will follow the second strategy.

SEARCHING FOR THE RIGHT ANSWERS

Beginning Dec. 1, 2011, the government established a special exchange rate of 7CUP:$1 for direct transactions, without intermediary, between state hotels and restaurants and agricultural cooperatives.

Although this decision is not officially recognized as a devaluation, it is the de facto creation of a new exchange rate for those operations. Later, in 2013, through Resolucion 9 of the Ministry of Finance and Prices, the special exchange rate was raised to 10CUP:US$1.

Another hint about future exchange rates is the experiment that began in 2013 with a select group of state enterprises. Under this experiment, the government grants them greater powers in their economic and financial management, as well as more autonomy in relation to government ministry control.

On a currency level, all operations of these enterprises are effected in CUP; they will use a different exchange rate, with possibilities to buy and sell hard currency in the Central Bank without exchange controls.

No precise information is available as to the exchange rate that will be used, but it seems it will be in the 10CUP:US$1 range.

What's more, according to unofficial information, in the second half of 2013 the sugarcane industry has begun to use multiple exchange rates in its accounting and operations that are different from the official 1:1 rate.

ARE MULTIPLE EXCHANGE RATES THE ANSWER?

As of now, it is known that sugar companies use three different exchange rates--12:1 for the accounting of their export revenues, 7:1 for the accounting of imports, and 4:1 for imports of Venezuelan oil and fuel.

The last hint that provides information about future monetary policy can be found in the recently created transportation service cooperatives, which will be allowed to buy both domestic and imported supplies--such as fuel, tires, parts and components--not at the official 1:1 rate but at 10CUP:US$1.

In summary, the new exchange rates for companies seem to hover around 10:1. Given that the convertible peso is pegged to the dollar, this translates to 10CUP:1CUC--which means a 900% devaluation of the official exchange rate for the sectors that participate in the exchange rate adjustment.

Seemingly, the idea of a complete currency reform has been cast aside, in favor of sectorial monetary reform that uses multiple exchange rates.

PESO DEVALUATION MAY OPEN OPPORTUNITIES

Obviously, the solution to the double-currency problem will follow the style of all other reforms--first, limited experiments with change on the margins, which are then expanded to the overall economy using the experiences obtained from the experiments.

The devaluation of the official exchange rate of the CUP will have effects on balance sheets and inflation, correcting assets and liabilities and relative prices towards a more precise and transparent valuation of economic facts. Likewise, devaluation will open windows of opportunity in the tradable-goods sector due to a rise of competitiveness.

At the same time, it will allow the CUP to become convertible, thus promoting other benefits like integrating the economy, promoting direct foreign investment, and in general strengthening the domestic market.

Pavel Vidal Alejandro is a Cuban economist and former Central Bank official who now teaches at the Universidad Javieriana in Cali, Colombia.
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Author:Alejandro, Pavel Vidal
Publication:CubaNews
Geographic Code:5CUBA
Date:Nov 1, 2013
Words:980
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