Floating Exchange Rate in Cuba: Can It End the Black Market?

The recent announcement by Cuban Prime Minister Manuel Marrero about implementing a daily floating exchange rate for the official currency market has stirred both skepticism and hope among the Cuban people. This move, intended to reshape the island's financial landscape, has been analyzed by Pavel Vidal, a Cuban economist and director of the Observatory of Currencies and Finances of Cuba (OMFi). OMFi provides insights into the behavior of the currency market and the evolution of financial indicators in Cuba's informal market.

In an interview with the independent media outlet elToque, which has been tracking currency fluctuations in Cuba since 2019, Vidal shared his predictions and concerns regarding the new policy. What is the government's proposal with this measure?

Government's Plan and Its Implications

Cuba's government aims to introduce a daily floating exchange rate system for currency transactions in 2025, applicable to exchanges carried out by official exchange offices (CADECAS) and banks. This initiative is unprecedented in the Cuban economy, traditionally characterized by centralized control. According to Vidal, who also teaches at Javeriana University in Cali, Colombia, and is a former official of the Central Bank of Cuba, the goal is to legitimize the currency market and diminish the informal exchange market's influence.

While formalizing the market could increase user security and enhance state control, there are significant concerns about its sustainability, especially amidst a severe economic crisis and a lack of international reserves.

Determining the Exchange Rate: A Critical Challenge

A major question is how the government will set the initial exchange rate, or the "day zero" rate. Vidal suggests it would likely align with the current informal market rate, approximately 320 Cuban pesos per dollar. However, the criteria for daily adjustments remain unspecified, leading to widespread uncertainty.

The absence of transparency may undermine trust in the system, particularly if there's an attempt to manipulate the peso's value to present a false sense of stability. In other countries, floating rates are usually determined by the interaction of supply and demand in a competitive market, a challenging prospect within Cuba's state-controlled environment.

Can the Cuban Government Sustain a Formalized Currency Market?

Initially, this system might encourage a shift from informal to formal exchange operations, reducing risks like fraud that are prevalent in the informal market. Vidal argues that informal markets are viable only when formal mechanisms are poorly designed or dysfunctional.

Despite potential initial benefits such as increased security for citizens and more effective state transaction control, doubts remain about the long-term viability of this formal market. Vidal points out several factors that could jeopardize its stability:

• Lack of Central Bank Autonomy: The Central Bank's limited independence could prevent it from adjusting exchange rates based on "technical" criteria. Political motives might lead the government to avoid necessary devaluations, fearing social unrest, particularly during energy crises.
• Misuse of Foreign Currency: There is a risk that dollars and euros collected by CADECAS might be diverted to pay government debts or fund imports, straying from the currency market's original purpose. This could cause an imbalance between buying and selling currencies, resulting in a significant "depreciation" of the national currency.
• Inflationary Impact: If the market is used to absorb foreign currency, it could become an inflationary mechanism, exacerbating inequality and poverty. Issuing Cuban pesos to cover market operations would further drive inflation.
• Technological and Operational Challenges: The banking system and CADECAS face serious infrastructure and technology deficiencies, which could hinder the successful implementation of a formalized market. Additionally, a lack of trained personnel and high demand for financial services add complexity to the process.

Additional Considerations and Future Prospects

The system is tailored for retail operations and won't affect the existing multiple exchange rates, like the official rate of 24 pesos per dollar, still applicable to business and government sectors. Questions remain about the participation of Micro, Small, and Medium Enterprises (MSMEs) and whether currency exchanges could extend to bank accounts—elements that would be groundbreaking in Cuba.

In conclusion, while introducing a floating rate in the official currency market could signify progress towards formalizing exchange operations in Cuba, structural challenges, a lack of transparency, and the country's financial constraints raise serious doubts about its medium and long-term sustainability.

The success of this policy hinges on the government’s ability to establish a transparent, technically sound system free from political influence, which in Cuba seems utopian. Otherwise, this measure might exacerbate the economic and social issues plaguing the Cuban population.

Though the announcement marks an unprecedented shift, the road to effective implementation is fraught with unresolved questions.