Cuba's Economic Potential: Beyond Hype And Wariness

by: Global Risk Insights

On March 20th, President Barack Obama achieved yet another diplomatic milestone by becoming the first U.S. leader to visit Cuba in 88 years. Obama's visit has so far been the pinnacle of the U.S.-Cuba rapprochement, which has produced a gradual easing of economic sanctions, renewed political ties, and a sense in Cuba and the United States that a full normalization of economic and political relations might follow.

The surprising improvement in U.S.-Cuban relations has raised hopes among corporate America and ordinary Cubans that renewed economic ties and an eventual scrapping of the U.S. embargo will bring about outstanding economic opportunities in the chronically underdeveloped Cuban economy.

Nonetheless, there are several reasons to be warily optimistic. The political leadership in the island seems reluctant to embark on a massive economic transformation and faces strong and protracted challenges.

Easing of sanctions and economic opportunities

The improvement in U.S.-Cuba relations remains a foreign policy achievement that few had foreseen. Although secret negotiations between Washington and Havana started in 2013, hosted by Canada and brokered by the Vatican, citizens of both countries were surprised at the pace of the rapprochement between these former Cold War foes.

Ahead of the official restoration of diplomatic relations between the two countries in July 2015, an easing of travel and trade restrictions was announced. American nationals would be allowed to visit Cuba without requiring a government license, and American carriers would be allowed to fly in and out of the island.

Since then, further restrictions have been lifted, of which the most notable are the elimination of a ban on Cuban financial transactions going through U.S. banks, the allowing of Cuban citizens to open U.S. bank accounts and using them to send remittances, the easing of restrictions for shipping and ferry services, the restoration of direct mail service, the authorization of exports of certain products, and increasing the amount people in the U.S. can send to Cubans by four times.

These developments have boosted business sentiment in the United States, particularly among the tourism sector. This sector is eager to enter the largely untapped Cuban market.

During Obama's visit, Starwood Hotels & Resorts (HOT) announced it would restore and upgrade three historic hotels in Havana, becoming the first U.S. hotel company to enter Cuba in over 50 years. Moreover, every single American carrier has expressed interest in flying to Cuba, while several cruise lines have announced plans to begin operating cruise services to the island.

As a result, American tourism is expected to surge strongly. Figures for 2015 estimate that it rose by 17% in 2015, while double-digit growth is expected in the years to come.

Ordinary Cubans will also benefit from these opportunities.

Those working outside the dominant government sector, making up roughly 10% of the Cuban workforce, will have the opportunity to increase their incomes by providing much-needed tourism services, such as guest hosting or catering. Moreover, the Cuban government will enjoy a much-needed increase in foreign exchange, boosting the overall economy, which grew by 4% in 2015 and is expected to gather pace in the upcoming years as a result of the deal.

Wary optimism

Nonetheless, economic hurdles for the Cuban economy remain. These can severely limit the impact of improved commercial ties with the United States.

Widespread shortages of basic staples remain a pressing concern on the eve of increased tourist arrivals. Higher demand for food products to cater to the needs of tourists will most likely push prices upwards, thereby decreasing the purchasing power of most Cubans working in the government sector. The Cuban government will therefore be pressured to increase wages, although this may add financial pressure on the country's budget deficit, already at 6%.

Cumbersome bureaucracy will also continue to deter investment. An example of this is Mariel, a planned port and free trade zone launched by the Communist government. So far, almost 300 enquiries from foreign investors have been submitted, but due to government inefficiency and unnecessary hurdles, only a dismal few have turned into actual investments.

The same applies to business opportunities across the island, where the government retains overwhelming control and imposes conditions that are unattractive for investors. These include the requirement for foreign firms to enter joint ventures with state-owned companies, tight labor controls and strict regulation.

Moreover, the need to reconcile Cuba's two currencies (Cuban pesos and Convertible pesos) remains a critical concern. The Communist Party has been hesitant to act boldly on this matter, fearing a currency crisis that could unleash a sharp devaluation. A devaluation would be catastrophic for the country's heavily subsidized industries.

Political and economic uncertainties will continue to loom over Havana in the upcoming years even as the island undertakes more market-friendly policies. Cuba's small population and sheer economic weight make it less attractive for risky investments. Moreover, the Communist Party has hinted that it is not willing to undergo a Russian-style transformation in its economy, and recent developments suggest that its adoption of liberalization policies may be even more gradual than China's.

Although the U.S.-Cuba rapprochement is expected to boost economic fortunes, it is unclear whether it will deliver increasing civil and political liberties in the island. During his visit, President Obama warily pointed out the profound differences between the two countries. Meanwhile, when asked about human rights, Cuban leader Raúl Castro simply replied he had said "enough".

Therefore, economic fortunes and political liberties are expected to move at different speeds, as long as Havana remains determined to retain some of the features of post-revolutionary Cuba.