Monetary and Exchange Rate Reform in Cuba: Lessons from Vietnam Pavel Vidal Alejandro Acknowledgements I would like to extend my sincere gratitude to IDE/JETRO for making possible my stay in Japan in 2011 and this research, which has been very important for my career and may contribute to the economic changes that are happening in Cuba at present. The advice of IDE researchers during my investigation process and presentations in seminars were very constructive, since they were both honest and thoughtful; I appreciate this enormously. Particular thanks are due to Mai Fujita, Nguyen Quoc Hung and all the people of the Latin American Studies Group. I express my gratitude to the staff of the VRF Program, especially Takao Tsuneishi and Kenji Marusaki. Three exceptional colleagues and friends, Kanako Yamaoka (my counterpart at IDE), Michihiro Sindo and Takashi Tanaka, as well as their family and friends, contributed not only to my research but to enriching my knowledge of the unique Japanese cultural context. Thanks to them I sometimes felt as if I were at home. I do not want to forget to mention the attentions and affection of Tomoko Murai from the IDE library. Finally, I would like to acknowledge the support of the Social Science Research Council (New York) for allowing me to visit Vietnam in 2010. Firsthand information and impressions I received from that study tour have been vital for this research. i Index of Contents Acknowledgements ............................................................................................................................ i Index of Contents .............................................................................................................................. ii List of Tables .................................................................................................................................... iii List of Figures .................................................................................................................................. iv Abbreviations and Acronyms .......................................................................................................... v Abstract ............................................................................................................................................ vi 1. Introduction .................................................................................................................................. 1 1.1 Macroeconomic Performance ................................................................................................ 1 1.2 The New Economic Reform ....................................................................................................... 2 2. Vietnam as Point of Comparison ................................................................................................. 5 3. Inflation, Liberalization and Adjustment ................................................................................. 10 4. Currency Unification .................................................................................................................. 15 5. Improving the Monetary Policy Strategy.................................................................................. 20 6. Financial Transformations ......................................................................................................... 24 7. Cuba´s First Step in the New Monetary Reform ...................................................................... 29 8. Conclusion ................................................................................................................................... 31 References ........................................................................................................................................ 33 The Author ...................................................................................................................................... 36 List of Major Works ....................................................................................................................... 36 ii List of Tables Table 1. Cuba: Macroeconomic Indicators, 2001-2010 …………………………………………2 Table 2. Cuba and Vietnam: Starting Point of Reform …………………………………………5 Table 3. Cuba and Vietnam: Social Indicators……………………………………………………9 iii List of Figures Figure 1. Cuba and Vietnam: Inflation Rate, 1986-2010 ……………………………………….11 Figure 2. Cuba and Vietnam: Fiscal Deficit, 1986-2010 ………………………………………..13 Figure 3. Cuba and Vietnam: Exchange Rate Evolution, 1987-2010 ….……………………..19 Figure 4. Vietnam: Interbank Interest Rate (overnight) and the Operational Target of Monetary Policy (base rate), 2008-2010 ………………………………………………23 Figure 5. Vietnam: Banking System Ownership, 2005 and 2009 ……..…………..……………27 iv Abbreviations and Acronyms Cadeca: Official Currency Exchange Agency CPI: Consumer Price Index CUC: Cuban Convertible Peso CUP: Cuban Peso EIU: Economist Intelligence Unit FDI: Foreign Direct Investment GDP: Gross Domestic Product Guidelines: Guidelines for Economic and Social Policy HDI: Human Development Index IFIs: International Financial Institutions IMF: International Monetary Fund ONE: Cuba’s National Statistics Office SOCBs: State-owned Commercial Banks SOEs: State-owned Enterprises UNDP: United Nation Development Program USD: American Dollar USSR: Union of Soviet Socialist Republics VND: Vietnamese Dong v Abstract Since 2010, the Cuban economy has entered a new period of economic reform, officially labeled as an “update of the economic model.” Cuba undertook a previous reform in the 1990s, but this was halted in the first decade of this century. Now, the new president, Raúl Castro, has insisted that the measures are permanent and structural. This paper evaluates the three objectives of the proposed reform regarding monetary and exchange rate policy: 1) currency unification, 2) improving the monetary policy strategy and 3) financial transformations. In order to weigh the extent of the visible contents of the Cuban monetary and exchange rate reform and obtain lessons from international experiences, some elements of the Vietnamese reform are taken as points of comparison. The starting point of the Cuban reform has many differences compared to Vietnam. The principal significance and benefit of looking at Vietnam lies in the similarities between the problems that Cuba is facing today in relation to those faced by Vietnam since 1986, when the country launched the Doi Moi reform, since both starting models share many characteristics of the Soviet-style system. The state sector in Vietnam was smaller than in any other reforming socialist economy. Large-scale state enterprises formed only a small part of its economy. Dollar (1993), Perkings (1993) and Riedel and Comer (1995) conclude that the structure of the Vietnamese reform was convenient for responding to a “big bang” liberalization in the late 1980s. When small units are the majority, it is easier to make the market system work. Therefore, the Vietnamese economy was in a better position to respond to the incentives provided by market-oriented reform than is the current dominant big state sector in Cuba. Early indications show that Cuban monetary and exchange rate reform will focus on the unification of the Cuban peso and convertible peso, the development of an interbank market, on the opening of personal credit and loans for non-state businesses, and the improvement of the strategy for the monetary policy through greater coordination and the establishment of rules. Taking into account the Vietnamese path of reform, and the changes that would seem necessary to achieve the very goals of planned Cuban reform for 2011-2015, a group of lacunae could be identified, such as the issue of government bonds, the entrance of foreign vi banks, greater competition and more flexibility in interest rates, as well as issues regarding transparency in the monetary policy. Cuba’s exchange rate adjustment in the 1990s was incomplete, since it took place only in the household sector. To eliminate the exchange rate and monetary duality, Cuban authorities must now extend the devaluation of the Cuban peso to the SOEs, joint venture companies and government institutions. They have to decide whether to do it gradually or by using a “big bang” approach, as in Vietnam. The large gap between exchange rates in Cuba (2,300%) speaks against a sudden devaluation of that magnitude, but also against the other extreme alternative of a too-slow adjustment that would require another twenty years of bearing the costs of monetary duality. Low inflation is an important advantage of the current Cuban reform compared to the reform of the early 1990s, and also compared to Vietnam in the 1980s. However, the ongoing liberalization process could put price stability under risk. Like Vietnam, Cuba will experience inflationary pressures; first, coming from the unavoidable exchange rate devaluation, and second, because of the shift from officially-set prices to market prices. If Cuba’s government is able to implement the planned labor adjustment and the fiscal restraints together with the opening to the non-state sector, then the risk of high inflation will be certainly lower. A matter that arises from the overall analysis of the Cuban reform is the inefficiency of focusing the liberalization only on microenterprises and agriculture without taking advantage of the enormous amount of resources invested in education during the last five decades. It seems far better for sustainable economic growth,