Cuba desperately needs to reform currency system, but timing couldn’t be worse

Cubans exchange Cuban peso (CUP) and convertible peso (CUC) notes. The Cuban government first announced it intended to unify its dual currency system in October 2013, but it hasn’t happened yet.
Cubans exchange Cuban peso (CUP) and convertible peso (CUC) notes. The Cuban government first announced it intended to unify its dual currency system in October 2013, but it hasn’t happened yet. AFP/Getty Images

The Havana money changer has his regulars: Cubans who want to travel abroad. American visitors. And, increasingly, Cubans who want to buy U.S. greenbacks and hold on to them.

“The dollar is backed by something. It doesn’t lose its value,” says the money changer, Miguel, who declined to give his last name because freelance money-changing isn’t legal in Cuba. He’s Cuban but lives in Mexico and frequently ferries cash and goods between Mexico and the island.

Cuba has an awkward dual currency system, with the Cuban peso (CUP) generally used by the Cuban population and the convertible peso (CUC) used by tourists, foreign companies and some state enterprises and private entrepreneurs. It’s been a goal for several years to unify the two currencies, but it hasn’t happened yet.

As Cubans wait for a move that will have a profound effect on their economic lives, some see hoarding dollars as a way of cushioning any potential shock.

“The natural instinct when the value of a local currency is uncertain is to flee into a hard currency,” said Richard Feinberg, a professor of international political economy at the University of California, San Diego. When the Cuban government finally decides to adjust the exchange rate and unify the currencies, he said, “potentially there will be big winners and big losers.”

The government has said the Cuban peso will be the survivor and the CUC will pass into history.

Rumors in late March that the currency unification would come within days and the CUC would be taken out of circulation prompted some jittery Cubans to withdraw CUCs from the bank and exchange them for Cuban pesos, dollars or euros.

The Central Bank of Cuba responded by issuing a statement on March 30 denouncing the “false information” and saying the CUC would remain in circulation until the monetary unification — an event that would be “communicated in an official manner. The date for the beginning of the process of monetary unification still hasn’t been defined.”

Economists say it will be difficult for the Cuban economy to advance without unifying Cuba’s currencies and widely divergent exchange rates. The government also is under pressure from foreign investment partners to clean up the economy and make it easier to do business. That includes having a singular exchange rate.

“It is impossible for Cuba to achieve a significant and sustainable improvement in the productivity of its economy so long as it operates with two national currencies, with multiple exchange rates between them and an official exchange rate that is excessively overvalued,” Pavel Vidal, a Cuban economist, wrote in a recent paper for the Cuba Study Group, a U.S. organization that supports development of a market-based economy and civil society in Cuba.

In 2014, state companies were told to begin preparing for the coming unification, dubbed Día Cero (Day Zero), and the government has been listing prices in both Cuban pesos and CUCs for the past couple of years in preparation.

The Cuban government began to mark prices in both Cuban pesos (CUPs) and Cuban convertible pesos (CUCs) a few years ago in anticipation of the day it unifies the island’s two currencies. AL DIAZ

In recent months Cuban officials have begun to hint that Day Zero is finally approaching.

In December, Cuban leader Raúl Castro — who had been expected to oversee the difficult task of unifying the two currencies but has announced he will retire on April 19 — said the unification couldn’t be delayed much longer. “No one can calculate the elevated cost for the state sector of the persistence of this duality, which favors the inverted pyramid where with greater responsibility a lower compensation is received.”

When a congressional delegation led by Vermont Sen. Patrick Leahy visited the island in February, Oregon Sen. Ron Wyden said Cuban officials “repeatedly said this was the year to get it done, to unify the currency.”

Currently, the CUP is valued at 24 Cuban pesos to $1, and the CUC is supposedly on par with the U.S. dollar, although a 10 percent surcharge and commission mean $1 U.S. will fetch only .87 CUCs at official exchange houses. The CUC exchange rate used by state enterprises also varies.

These days money changers are offering in the range of .93 to .95 CUCs for a dollar. Miguel, the money changer, says he won’t be sad to see the demise of the CUC. “This money isn’t worth the bother,” he said as he derisively flipped away a CUC note.

Despite all the foreshadowing that Day Zero is approaching, Domingo Amuchastegui, a former Cuban intelligence analyst who now lives in Miami, says now is not the time to undertake currency unification. “Any notion of a quick currency unification and new exchange rate is for me technically and socially impossible now. You cannot undertake such a gigantic step when economic resources are at their worst.”

The Cuban government has projected the economy will grow by 2 percent this year, but a number of independent economists think that is wildly optimistic given the economic crisis in Cuban benefactor Venezuela, further restrictions on U.S. travel and trade under the Trump administration, and the impact of Hurricane Irma.

One necessary precondition, Amuchastegui said, is to show that the Cuban peso has more effective purchasing power. But in the wake of Irma’s charge along Cuba’s north coast last September, prices have been increasing, especially for construction materials and food.

“The timing is off. Now prices are sky high. The whole currency unification process needs to be gradual. It can’t be zero hour,” Amuchastegui said.

Feinberg doesn’t believe that Castro’s expected successor — First Vice President Miguel Díaz-Canel — will be in a rush to unify the two currencies either. “If I were Díaz-Canel, the last thing I would want to address early in my term would be something as politically volatile and technically complex as currency unification,” he said. “There are so many challenges.”

One of the big ones is the possibility of setting off a further inflationary spiral.

Richard Feinberg says it will be a daunting task for Raúl Castro’s successor to unify Cuba’s unwieldy dual currency system early in his term. Castro is expected to retire as president on April 19. LUIS CHOY

Once the currencies are unified, “I think the average Cuban thinks that real wages will go up. That means that demand would go up, and where are these goods coming from? If you increase demand without increasing supply, you get potentially serious inflation,” said Feinberg, a senior fellow at the Brookings Institution and a national security adviser during the Clinton administration.

“The Cuban government hasn’t laid the foundations in terms of public awareness or announced how they will deal with potential inflation,” he added.

While Cuba’s overall economy is expected to benefit when the exchange rate is adjusted because prices will be transparent and there will be clear signals about market conditions, there will also be losers, Feinberg said.

While exporting companies should benefit from currency reform, some state enterprises that have been propped up by artificial exchange rates could find themselves bleeding red ink and unable to compete. Cubans who work for such firms could lose too. “Cubans expect the government to provide a cushion or some form of subsidies for the losers — and that’s expensive,” Feinberg said.

Vidal, a professor at Pontificia Universidad Javeriana in Cali, Colombia, said state enterprises that show permanent losses should be closed or merged instead of being allowed to operate in a “financial bubble” where they are sustained “by implicit subsidies received every time they pay for imported inputs using an overvalued exchange rate.

“This bubble must be burst, and the state sector must be restructured,” he wrote in his paper for the Cuban Study Group. “Enormous amounts of financial and human resources have been wasted in supporting state enterprises with no economic value.”

The government faces two choices, Vidal said: Undertake a structural currency reform that will have real impact on the economy, or do an innocuous reform allowing price distortions, depressed salaries, and artificial profits at some state enterprises to continue.

Vidal said if the Cuban government chooses true currency reform, it should be accompanied by not only a greater opening to foreign investment but also by liberalization of the private sector. An expansion of the private sector, he said, “would allow Cuba to absorb the unemployment that would be produced from enterprises that go bankrupt.”

Follow Mimi Whitefield on Twitter: @HeraldMimi