In Cuba, a Potential for Prosperity

In Cuba, a Potential for Prosperity
Analysis AUGUST 5, 2015 | 09:15 GMT Print Text Size

Forecast
- Cuba and the United States will continue to strengthen political ties
in the coming months and years.
- In the short term, Cuban tourism revenue could increase and certain
financial restrictions ease, but the country may still feel the impact
of Venezuela's economic downturn.
- In the longer term, the impact of the Cuba's opening will
depend on Havana's ability to address structural issues in its economy
and on when and how the United States decides to lift the trade embargo.
- The Cuban government will likely introduce reforms gradually and
selectively to take advantage of economic opportunities while
maintaining a firm grip on political power.

Analysis

Cuba has been shunned for so long that it is easy to forget just how
important it is to the United States. The island nation has a prominent
position at the mouth of the Gulf of Mexico, separating access to the
gulf into two chokepoints: the Yucatan Channel and the Straits of
Florida. Cuba is also situated on the sea-lanes between the U.S. East
Coast and the Panama Canal, the shortest route for naval traffic between
the two coasts of the United States. Cuba, which lies just 145
kilometers (90 miles) off the coast of the United States, has thus been
pivotal to safeguarding economic activity in the Gulf of Mexico and
naval transport routes beyond that. When the United States and Cuba are
on opposing sides, the U.S. imperative is to try and neutralize and
counter foreign support to Cuba from more powerful sponsors interested
in meddling in the United States' backyard. If Cuba is on friendly terms
with the United States, this task becomes all the more manageable.
In terms of Cuba's own economy, it has historically been driven, like
many Latin American countries, by the production and export of raw
materials. Cuba's most important resources have traditionally been sugar
and tobacco, although the country is also a significant producer of
nickel and hard alcohol. However, in large part because of its strategic
location and interest from external powers, Cuba has experienced a
unique political and economic trajectory over the past six decades.

The Cuban Revolution of 1959, led by Fidel Castro, dramatically shifted
Cuba's economic structure from a capitalist economy integrated with that
of the United States to a socialist, centrally planned economy oriented
toward the Soviet Union. With Castro's revolution came
the nationalization of the Cuban economy, sweeping land reforms and
radical wealth redistribution. The Cuban government took control of
virtually all major economic activity in the country, even to the point
of confiscating foreign — and particularly Western — businesses
operating on its soil, including the extremely powerful U.S.-based
United Fruit Company. At the same time, the new Cuba became closely
dependent on the Soviet Union for key goods such as oil and food.

With the collapse of the Soviet Union in 1991, Cuba lost one of its
major economic patrons. The highly subsidized oil shipments it had been
receiving from Russia fell 86 percent from 1989 to 1992, and food
imports from Russia dropped more than 40 percent in the same period.
These factors, along with a major drop in sugar prices, provoked a major
economic recession in Cuba in the early 1990s, which in turn sparked
some important reforms to the Cuban economy: Fidel Castro's government
opened the country to tourism and limited foreign investment,
while semi-legalizing the use of the U.S. dollar.

Nevertheless, Cuba still remained largely closed off to the United
States, which retained a trade and travel embargo on the island. Cuba
eventually found a new economic patron in Venezuela, whose left-wing
government under President Hugo Chavez began sending subsidized fuel
shipments to Venezuela as the Soviet Union had done. Even with
the political transition from Fidel to his brother Raul Castro in 2008,
when Cuba began engaging in some limited economic reforms such as the
legalization of informal business activity, the state continued to play
a dominant role in an economy that remained largely closed off to
the United States.

A Diplomatic Opening: Short-Term Effects

The death of Hugo Chavez in 2013 and rising political and economic
instability in Venezuela over the past two years have once again
endangered Cuba's primary economic patron, which in part explains the
latest major development trend in Cuba's political and economic
evolution: renewed diplomatic ties with the United States. Beginning in
late 2013, there were signs of a warming between Cuba and the United
States, including a handshake between U.S. President Barack Obama and
his Cuban counterpart, Raul Castro, at a memorial service for Nelson
Mandela, and the start of bilateral talks in 2014 over various
issues, such as the U.S. embargo on imports from Cuba and the use of
Guantanamo Bay.

These talks culminated in a major breakthrough in December 2014, when
Cuba released former U.S. contractor Alan Gross in exchange for three
Cuban spies who had been held in the United States. Shortly thereafter
officials from both countries announced high-level political discussions
focused on renewing their diplomatic relationship. Then, in March 2015,
the U.S. Office of Foreign Assets Control removed dozens of Cuban
companies connected to tourism and shipping from the sanctions list. On
July 1, Obama finally made the official announcement that the United
States and Cuba were to re-establish diplomatic ties and eventually
reopen embassies in Havana and Washington.

Washington has also loosened economic restrictions to allow more money
to flow into Cuba. Americans currently send $2 billion to Cuba in the
form of remittances each year, but new changes allow individuals to send
up to $2,000 per quarter to family members in Cuba, up from $500 per
quarter previously. In addition, U.S. banks can now process credit card
transactions from Cuba, a move that enables Americans who travel to the
island to use their credit and debit cards.

Thanks to the diplomatic thaw, the Cuban tourism sector is on the
rise. Tourist traffic to the island is up 15 percent compared with the
same period last year, with around 1.7 million people visiting in the
first five months of 2015. Moreover, each of the first five months has
seen a double-digit increase in visitors — many of whom are coming from
the United States. For May that number jumped 21 percent. Perhaps not
coincidentally, Cuba's economic performance in the first half of 2015
registered a growth of 4.7 percent, which shows a reversal of the
downward trend between 2013 and 2014. Now Cuba's economy is projected to
grow 4 percent this year, largely driven by the construction and
agriculture sectors. That is almost four times its growth rate in 2014,
the fastest climb Cuba has seen since 2008. Even if economic statistics
out of Cuba are not always completely reliable, they can still help
paint a general picture of the country's prospects for growth.

The Long-Term Outlook

The next few years may be promising for Cuba's economy. The island has a
highly literate population, relatively cheap labor, abundant population
and natural harbors. Cuba also has a small but promising biotechnology
sector with the significant potential for medical and drug
manufacturing. Indeed, many international pharmaceutical companies
already having identified Cuba as a potential site for drug making.
There is also potential for Cuba to serve as a transshipment
hub, contingent on upgrades and expansions to the country's ports.

But despite these factors and the initially positive economic signs amid
the thaw between Cuba and the United States, the imbalances created by
five decades of economic isolation will constrain Cuba's long-term
economic growth. The Cuban government remains by far the largest
employer on the island, and state-owned exporting businesses (as well as
limited joint ventures with foreign firms) are highly inefficient
compared with foreign competitors. Cuba's two-tiered currency exchange
rate — in which a convertible peso is pegged to the dollar and used for
foreign trade and the tourism industry, while the local peso is used for
local goods and for paying local wages — is also problematic and
dissuades foreign investment. Moreover, the country's restrictive
foreign investment law, which taxes foreign-owned firms heavily and
limits international arbitration to settle disputes, is a major drag on
foreign investment.

The Cuban government does have plans to have a legal draft in place for
the unification of the dual currency rates by sometime in 2016, but the
pace of Cuba's opening to foreign capital will in large part depend on
whether the United States actually ends the Cuban trade embargo within
the next few years. According to U.S. law, Congress has to see a
transitional government in place in Havana before it has the authority
to amend or annul the ban on trade with the island. With Cuban President
Raul Castro set to step down in 2018, the United States could wait until
then to see if Cuba meets the legislative criteria to lift the embargo.
A second option, promoted by some members of the U.S. Congress from both
sides of the aisle, is for Congress to amend the law underpinning the
embargo, thereby removing the legal rationale for maintaining the ban.

Even if Congress does lift the embargo, Cuba must manage its internal
structural problems, including a monetary policy divorced from trade,
poor energy and transport infrastructure and lack of capital stock — all
of which limit its economic growth. In the coming years, Havana will try
to address these issues but take care to keep those economic reforms
from undermining its strong grip on power as the presidency transfers
from Raul Castro to First Vice President Miguel Mario Diaz-Canel Bermudez.

Given the tenuous political situation, Havana's reforms are likely to be
measured and gradual, and certain structural issues may impede the
process. Cuba nevertheless has the potential to become an attractive and
competitive low-end and middle-end manufacturing environment and see
strong economic growth in the wake of its opening with the United States.

Source: In Cuba, a Potential for Prosperity | Stratfor -
https://www.stratfor.com/analysis/cuba-potential-prosperity