Ten-point Program to Stabilize the Cuban Economy

Until August 2022, year-on-year inflation in the Cuban economy stood at 34.1%, including a remarkable increase of 54.2% in food prices. Since April, the inflationary trend has accelerated, rising on average at a rate of 3% every month.

These are data from the Cuban National Office of Statistics and Information (ONEI). They are calculated on a Consumer Price Index (CPI), which underestimates true inflation, because their base is outdated 2010 data. ONEI only gives an 18% weight for private market products in calculating the household consumption basket, which is an underrepresentation.

In 2021, the ONEI’s CPI underestimated between five and six times effective inflation.^[1]  If we apply this same underestimation factor to current data, we can calculate that current inflation exceeds 150%, one of the highest on the planet.

The high inflation rates in the Cuban economy, as always and everywhere as is usually the case, have a high monetary component fed by an excessive fiscal deficit. The amount of money in circulation (cash plus savings accounts) increased from $65,028 million in 2019 to $190,917 million in 2021 (Table 6.2 of the Statistical Yearbook 2021, ONEI).  Driving this monetary component is the financing of a burgeoning budget imbalance that increased tenfold in the same period: in 2019 the fiscal deficit was $6,435 million CUP (Cuban pesos), and in 2021 it was $63,697 million CUP (Table 6.2 of the 2021 Statistical Yearbook, ONEI).

Inflation has greatly devalued state wages and pensions, pushing thousands of families into extremely difficult living conditions. It has exacerbated food security and social inequality. The out-of-control prices have nullified the potential benefits of the 2021 monetary reform and threaten the expansion of nascent small- and medium-sized private companies. Along with blackouts and widespread shortages of food and medicine, inflation is a driving factor fueling the record flow of migration to the United States.

Despite the fact that inflation has been rising steadily for three years, Cuban economic authorities have not developed an economic stabilization program. In order to contribute to the national debate and to generate ideas that will help control an inflationary process that mainly affects Cuban families, I propose below some reforms and policies that appear fundamental to craft a program of economic stabilization.

Scope

For a stabilization program to be effective, it must include fiscal austerity measures and changes in monetary- and exchange-rate policies, as well as structural and institutional changes. It is important to reduce expenditures and implement monetary and exchange rate adjustments, but growth and efficiency must also be boosted by removing well-known obstacles. In order to balance the sacrifice and uncertainty from necessary economic adjustments that the Cuban people would suffer, we must open new spaces that generate opportunities and engender optimism. We need to keep in mind that a program developed to tame inflation also requires transformations in the institutional and regulatory frameworks related to monetary and fiscal policy.

For example, the economic stabilization program applied in Cuba in the 1990s (known as medidas de saneamiento financiero) was effective because, at the same time that fiscal and monetary adjustments were taking place, there were openings to tourism, foreign investment, remittances and self-employment, among other structural reforms concurrently adopted. These austerity measures were then combined with transformations of the financial system’s regulatory framework, which included the creation of the Central Bank of Cuba (BCC), CADECA (exchange houses) and new specialized banks. Monetization from the BCC was limited to the fiscal deficit approved by the National Assembly, one among other institutional reforms.

Today, it is time to reform and liberalize additional aspects of the economy. The authorization of SMEs (small- and medium-sized enterprises) is an important recent step, but it is insufficient. Proposals to transform the economy abound, in particular because the Cuban government has insisted on a model with a nationalized and excessively regulated economy that today almost no other nation considers a viable option. Its negative consequences for the nations that have adopted the same model have been widely documented.

Monetary Policy

1. Given the cost in terms of credibility after the failure of the monetary reform implemented on January 1, 2021, the failed monetary intervention from last August, and the resulting out-of-control inflation, explicit limits should be placed on the management of the money supply by the Central Bank. Monetary policy must signal convincingly a commitment to controlling inflation, managing expectations and demonstrating sustainability.
   
   One option is to adopt a policy rule for the transparent management of the money supply, using publicly disclosed government statistics supported by legislation (the adoption of an authorizing Decree-Law, for example) that completely prevents the government monetizing fiscal deficits. For greater credibility, the implementation of the rule should be overseen by an independent committee made up of academics and other experts who are not subject to governmental pressure. An example of a monetary rule existed for the convertible peso (CUC) under a currency board: for every CUC in circulation there was a reserve dollar in the Central Bank. The CUC worked well until 2004, when this rule was broken and an indiscriminate issuance of CUC began, fueling in great part the Cuban banking crisis of 2009 and damaging the CUC convertibility and public confidence in the following years^[2]. The currency board is not the only possible way of implementing the new monetary approach; there are other options that should be studied (a recent model available in the region as a reference is Uruguay's monetary policy until 2020).

2. Create an inflation-adjusted (indexed) unit of account (such as the UVR in Colombia, the UF in Chile, and the UI in Uruguay). This does not stop inflation, but it helps reduce its impacts. It protects savings, investments and the flow of trade relations in the midst of inflation. It represents an alternative and a brake on dollarization.

3. Related to point two, create financial instruments with interest rates in units of account indexed to inflation, i.e., government bonds, term deposits and bank loans. This allows the financial system to coexist with inflation and correct the distortions currently generated by negative real interest rates. These instruments would help increase demand for assets in Cuban pesos and help stop the depreciation of the exchange rate and dollarization.

Exchange Rate Policy

4. Option 1 (without a concurrent structural change): a) discard the policy of effecting net purchase of foreign currency through foreign exchange operations with the population. The retail hard currency market does not exist for the government to collect foreign currency. Discarding this current policy would help the entry of foreign currency because it offers a safe and legal channel for those outside to send remittances and for tourists to exchange money ^[3]; and b) move to a managed float regime of the retail exchange rate. The period from 1995 to 2001, when the Central Bank set the exchange rate based on the balance between buying and selling foreign currency in this market, can be used as a reference.

5. Option 2 (with a concurrent structural change): eliminate CADECA's monopoly in the retail currency exchange market. Legalize the now informal operators of the informal currency exchange market (and others who are considering entering it), allowing non-state actors to manage exchange houses (including authorizing the administration of exchange houses by SMEs). The exchange rate of the Cuban peso in the retail market would be flexible and would reflect daily the conditions of the supply and demand of foreign currency in cash for individuals, nationals and tourists.

6. Design an exchange rate regime that updates the wholesale exchange rate, taking into account the trend of the retail exchange rate and other macroeconomic variables, supply and demand in the wholesale market, while offering greater exchange rate stability to the business sector. Given the characteristics of the Cuban economy, crawling bands^[4] could be adopted (a current model might be Singapore's exchange rate regime). 
   
   Redesign the implementation of an economic plan and the state budget so that they can operate with an official exchange rate that adjusts periodically. A transition period would be developed to achieve convergence of the retail and wholesale exchange rates (although they do not have to be exactly the same, as is the case in other economies). This would require, for a time, periodic devaluations of the official rate.
   
   The monetary rule (point two) and the exchange rate regime must be consistent once it is determined what will be the nominal anchor of the economy.

Fiscal Policy

7. Reduce the fiscal deficit by resizing the budgeted sector, closing or restructuring unprofitable state-owned enterprises, and implementing additional austerity measures. The sale of assets to the private and cooperative sector should be analyzed.

8. Structural redesign: change the sources of income of the government budget. Move from a budget supported by the monopoly rents of a state sector (largely inefficient) to a budget financed by a progressive tax system of a competitive and dynamic economy with the more active participation of the private sector both nationally and internationally. Transfer to the private sector (including its workers) the operation and ownership of non-strategic state enterprises, which would require a profound reconfiguration of the current economic model.

9. Design a rule (transparent and legally supported) to put limits on fiscal deficits and public debt in a medium-term fiscal framework and strengthen the financing mechanism through the issuance of public bonds. For greater credibility, the rule should be overseen by an independent committee made up of academics and other independent representatives.

International Relations

10. Manage international financing in support of the macroeconomic stabilization program, highlighting to creditors its structural and sustainable nature. On the basis of this structural adjustment program, renegotiate the external debt with creditors and knock on the doors of multilateral financial institutions. If possible, include this issue in the dialogues held with the United States and the European Union, with a view to creating a more favorable international environment for trade and financial relations and foreign investment.

^[1]  See Luis R. Luis: “Inflation in Cuba 2010-2021” ASCE blog 2021 y Pavel Vidal, “Cuba’s New Monetary and Exchange System: How are They Progressing?” ASCE Webinar, February 2021

^[2]  See Pavel Vidal y Mario González-Corzo: “Cuba's banking crisis: macroeconomic antecedents, principal causes, and recent policy responses.” International Journal of Cuban Studies, 2010, p. 201-216.

^[3]  https://eltoque.com/150-pesos-por-dolar-Cuba

^[4]  Exchange rate bands allow markets to set rates within a specified range; edges of the band are defended through intervention. It provides a limited role for exchange rate movements to counteract external shocks while partially anchoring expectations. 
https://en.wikipedia.org/wiki/Exchange-rate_flexibility; https://en.wikipedia.org/wiki/Exchange_rate_regime