Private business in the new monetary and exchange rate environment

At the close of this 2020, the Cuban economy will see its worst result since 1994. All indicators point to a contraction of Gross Domestic Product (GDP) in the order of 8-10 percent. This, in the midst of an acute shortage of hard currency, has forced a cut in imports and an accumulation of defaults with suppliers and creditors. In this context, it is unthinkable that the private sector will not be affected.

The combination of restrictive measures aimed at controlling the pandemic and the economic crisis has been reflected in the health of businesses. Many have had to close down for a long period, others have seen their activity levels significantly reduced, and a few will not be able to resume their operations. This affects not only their owners, but also a large number of employees and their families, whose income is significantly reduced in a period of economic hardship. 

As part of the government’s anti-crisis strategy, and the necessary acceleration of changes that are part of the Updating of the country’s socio-economic model, since September 2020 various media have begun to argue the need to implement the so-called “monetary restructuring,” in the near future. That is, the transformation of the monetary and exchange system in force since 1994. This is based on the existence of two currencies (Cuban peso, or CUP, and the convertible peso, or CUC); multiple types of exchange rate (two in the beginning: the official 1 CUP = 1 CUC = 1 USD; and the open 25 CUP = 1 CUC at the current valuation); and exchange controls (there are restrictions for companies and individuals regarding the amount of dollars they can buy at the current exchange rate, especially for companies), and strict controls. This allowed for the isolation of the “emerging sectors” (tourism, exporters, remittances) from the imbalances of the segment that operated in pesos.

A characteristic of this system is that the state-run productive sector and households continue operating in separate, non-contact circuits. For example, state-owned companies do not go to a bureau de change to buy convertible pesos, even if they have the liquidity to do so. 

This peculiarity, together with the productive fragmentation of the economic model, has resulted in a singular status for the Cuban private sector (self-employment). On the one hand, until very recently, its relations with the rest of the productive apparatus were very scarce, causing the weakening of the economy’s internal integration.

On the other hand, from a policy standpoint, and in the monetary system itself, the private sector is treated as part of the household sector. There is nothing in the national accounts that allows for differentiation. This causes serious problems because it distorts economic categories. An example is private consumption, of which a significant part is actually intermediate consumption by the self-employed sector. Although the effects do not end there.

However, beyond the prejudices, some favorable effects can be pointed out. Very relevant to the issue in question is the fact that private businesses have already achieved viability with a devalued peso (25 CUP = 1 CUC), an element that differentiates them from state-owned companies. In this sense, they are better prepared to deal with further devaluations. That said, according to the proposal explained by the authorities, the private sector must be aware of very possible negative impacts, which should be analyzed based on the particular conditions of each business, and a contingency plan should be put in place.

First, the programmed price increases will extend to the sector’s supplies, and services that are currently subsidised, for example, public services such as electricity, water, gas and fixed telephony. While the government understands that the prices of sector products will also have to increase, there is tension regarding the extent of this adjustment. The authorities expect it to be moderate, so that overall inflation remains within the margins calculated ex-ante. This may lead to a loss of profitability in some entities.

Secondly, some self-employed people may find it difficult to pass on the entire adjustment to prices, because this depends on the characteristics of the market in which they operate. If competition is high, some of that variation is assumed by the seller. The third element is that the cost structure is different according to the activity being carried out, so the impact is not homogeneous for the whole sector. Some will be more affected than others.

Cost pressure also stems from public sector wage increases. Unlike the latter, there is no budget support for private businesses in this sense. All increases must be covered by increased sales, at a time when demand is faltering due to the economic crisis. Again, the contraction in demand does not affect all businesses equally.

Since the beginning of the communications campaign, and the postponement of the starting date of the monetary restructuring, other tendencies have been incorporated that the private sector should attend to. On the one hand, prices have shown an upward trend in recent weeks. This is the result of shortages, but also of the expectations regarding future increases. The private sector must be vigilant to avoid being identified as responsible for this trend. Price instability complicates the scenario for eventual adjustment.

Another issue to watch is the exchange market. In view of the advance of dollarization, and the inconvertibility of domestic currencies, the only alternative is the informal market, which exposes businesses to problems of all kinds, beginning with the fact that it is a crime, and the authorities have not shown tolerance. This aspect should find a positive answer in the “restructuring.”

In short, both the current economic context and some policy measures may require further adjustment by the private sector. The reopening of borders and the installation of a U.S. administration more identified with Obama’s policies may soften the productive scenario in the coming months. However, the challenges are enormous – be prepared and stay informed!