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AmericasOctober 3 2016

Is Cuba ready for a sanctions-free future?

The collapse of its key economic and political allies has prompted Cuba to re-engage with the international community. Moreover, the promise of an end to sanctions from long-time antagonist the US has given Western businesses the hope of valuable business deals – but can they see eye to eye? Silvia Pavoni reports.
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“We’ve had a process for doing things. Some [things] went well and some didn’t,” says Joaquin Infante Ugarte, an adviser on Cuba’s state-run economy, meticulously describing plans to update the socialist country’s development model on a humid June afternoon in Havana.

Mr Infante Ugarte, vice-president of the National Association of Economists and Accountants of Cuba, lived through the armed revolution of the 1950s against the US-backed government of the time, which reshaped the Caribbean island’s social and economic fibre. In the decades since, he has seen some of his grandchildren and great-grandchildren moving to and growing up in the US.

“The ‘American dream’ is our youths’ problem; we have to improve their lives here,” says Mr Infante Ugarte. An hour later, as we bid farewell, the lights at the association go off in an apparent power cut. “This is Cuba,” he shrugs.

A tipping point

The country has reached a precarious point in its history. It has grown dependent on the benevolence of countries aligned with its Communist political principles, initially Russia. After the collapse of the Soviet Union, near neighbour Venezuela became a key partner and a source of cheap oil, which it provided in exchange for the expertise of Cuba’s highly trained professionals, especially teachers and medics. But with Caracas now suffering its own crisis, its contribution to its Caribbean ally is under severe pressure and supplies have dwindled. Cuba needs to find new trade partners and foreign investors, while retaining the values it holds dear, such as free universal healthcare and education.

Over the past few years, the government has devised programmes and passed legislation that appeals to the part of the world it once so strongly opposed, announcing a new economic programme in 2011 and passing a foreign investment law in 2014. This September it signed an agreement with Latin American development bank CAF to receive technical assistance with its economic plans and become a member at a later stage, as CAF president Enrique Garcia notes.

Crucially, in 2015 Cuba restored official relations with the US, which has now a fully functioning embassy in Havana – a development that has bolstered hopes of an end to the punishing sanctions the US has levied on Cuba since 1960 as part of its larger Cold War against communism.

Lifting el bloqueo

A series of measures was taken recently to permit US dollar transactions with Cuba and for US citizens to travel to the Caribbean island for specific reasons other than tourism, which is still forbidden. Some believe the US embargo – or as Cubans call it el bloqueo, or 'the blockade' – will be lifted by the first quarter of 2018. Signs of a more open Cuba are becoming evident, but so too are worries about whether or not the economy is being steered down a sustainable path.

Tellingly, US hospitality group Starwood was allowed to squeeze through a gap in the embargo by receiving authorisation to manage the Cuba Four Points by Sheraton hotel in Havana, a hotel owned by the Cuban military and formerly known as Quinta Avenida, which the group has been running since the end of June.

Furthermore, in June Cuba permitted the local use of the credit card of a Florida-based lender, Stonegate Bank, which has been serving US officials in the country – the first American bank ever allowed to do so. The 10% fee that is usually charged to exchange dollars into pesos does not apply to Stonegate’s credit card, and its CEO David Seleski believes more deals will follow.

“There’s a fascination in the US with Cuba, it’s the ‘forbidden fruit’ – and that is true for individuals as well as for businesses,” he says. “I’d say that most Fortune 500 companies in the US have visited Cuba either quietly or openly, and explored [its] potential.”

A flying first

Reaching the island is also becoming easier for those companies. In August, JetBlue flight 387 from Fort Lauderdale in Florida touched down in Santa Clara, east of Havana, in the first scheduled commercial flight from the US in more than half a century. 

According to Cuba's tourism ministry, there was a 12% jump in visitor numbers in the first half of 2016. Even higher spikes are expected when the US tourism ban is lifted completely, which insiders believe will happen by the second quarter of 2017, and 2 million US tourists are expected to visit the island every year.

“The supply is far less than the growth projections: Cuba needs 180,000 new hotel rooms by 2020 just to keep pace with growth,” says Timothy Ashby, chief executive of Pembury Capital, a specialist adviser that has worked with Starwood on its Cuba deal.

Expropriation deals

Mr Ashby is also a former US official with experience of US claims over expropriated property in Cuba (Starwood is among the claimants). An official plan to address such claims, valued by the US government at $1.9bn, excluding accrued interest, must be agreed before the embargo can be lifted.

The two governments have created working groups to negotiate the process and have held two formal and several confidential meetings, according to Mr Ashby. “I believe that the larger claims will be settled with swaps for concessions, real estate leases and investment tax incentives, and the smaller value claims will be settled with bonds. This bodes well for future opportunities in the tourism sector,” he says.

Also in the offing, last year UK property developer London & Regional announced plans to develop a $500m luxury tourist resort in Cuba, to include an 18-hole golf course, in association with Palmares, a state company charged with developing Cuban golf. In August, two French firms, the construction group Bouygues and airport authority Aeroports de Paris, were chosen to modernise, expand and operate the José Martí International Airport in Havana to cope with a boom in tourism.

Doing business in Cuba has improved greatly, according to Mr Ashby. “A few years ago, [foreign companies] had major problems in terms of repatriating profits but that changed," he says. "Cuba now has a robust foreign investment law that allows for the repatriation of profits and dividends. It allows for tax holidays for certain joint ventures, and many companies and investors in tourism as well as other sectors are taking advantage of these incentives.”

Call to manufacturers

Opportunities also abound in manufacturing and logistics, as Cuba is conscious it needs to improve productivity and reduce dependence on imports. West of Havana, the Special Economic Development Zone of Mariel offers incentives and tax breaks to foreign firms based there with the aim of creating a manufacturing and logistics hub.

When The Banker was in Cuba in June, it was not allowed to visit the area, but Katia Alonso Canizares, director for foreign investments negotiations at the Ministry of Foreign Trade and Investment, says several deals with foreign companies have been secured and construction work has started. These include a joint venture between multi-national Unilever and the state-owned Intersuchel to build a $35m homecare and personal products factory to open in 2017. Unilever declined to comment on how the works are progressing.

The Cuban administration has identified 11 priority sectors needing either major capital, management skills or specific technology. These include renewable energy as the country looks to dilute its dependence on oil and take advantage of its natural resources: solar, wind and biomass energy. The latter, for example, can be obtained from a highly aggressive type of weed, the marabou.

Originally from South Africa, this dense woody plant now covers an estimated 1.7 million hectares of once-productive Cuban land. Utilising it would boost energy supplies while aiding agriculture. Investors include British firm Havana Energy, which entered in a joint venture with a firm controlled by Cuban sugar monopoly Azcuba in 2012, and has secured financing on the first factory, according to the company.

“In the past few years, the topic of foreign investment has become important in our country,” says Ms Alonso Canizares. “The legislative framework is clear, as are our priorities. There are many businesses interested, we’re not short of partners from all over the world, both countries with which we already have relations and new ones.”

However, she complains that foreign investors’ approach to projects make negotiations harder for their Cuban counterparts and can display a lack of understanding of each other’s expectations. “There’s an initial idea but during negotiations, the foreign firm changes the project and so it’s difficult to close the deal. They should consider the diversification we’re providing [to their businesses],” she says.

Slow change

Despite the great interest and initial deals, Cuba is experiencing problems that go beyond the energy shortages such as that which turned the lights off at the National Association of Economists. According to one professional closely acquainted with the facts, concerns are emerging about Cuba’s ability to meet a crucial payment to official creditors at the end of October, having agreed on a restructuring of such debt less than a year ago, in December 2015, with a group of 14 countries (out of the 20 members of the Paris Club). This was Cuba’s first concrete step towards rejoining the international community.

Although data on its foreign reserves is not available, few doubted Cuba’s ability to honour the commitment, particularly considering the size of the deal: it would pay $2.6bn of the total $11.1bn claims over a period of 18 years. “I think that this liquidity crisis will end up in a very hard [new] restructuring,” says the professional. “It’s like a plane running out of fuel: is it possible to land a [Boeing] 747 without power? Yes, it is. Is it easy? No, it is not.”

Because of the Venezuelan crisis, fuel is indeed running out in Cuba, and the foreign investment that the island now seeks with which to replenish its reserves is only flowing in slowly, as its socialist leaders and international companies struggle to see eye to eye.

Military movements

Any investors that expect Cuba to react in the same way to their business proposals as any other counterparty are in for a shock, but lately the country has surprised even the most experienced professional, according to one investor who has noted a recent change of tone in the country. “Their body language towards the West and the banking system has been going backwards, not forward, ever since [this August],” he says about the fact the sovereign has yet to reached an agreement with the group of commercial creditors owning $1.2bn of Cuban paper, with total claims estimated to be between $6bn to $8bn including interests and late payment charges.

He also notes a stronger involvement of the military in the tourism sector, which others have described as a sign of an “internal power struggle” to gain exposure to the parts of the economy that have greater international appeal. In August, the military’s business arm took over a previously uniquely autonomous venture, Habaguanex, which was run by Eusebio Leal, a well-known figure often dubbed the ‘Havana city historian’. Until now Habaguanex, which takes charge of the restoration and management of the old part of Havana, could independently reinvest any profits from the dozens of hotels, stores and restaurants it manages, into the project.

Peter Hakim, president emeritus of the Inter-American Dialogue, says: “I’m beginning to see a flurry of heavily negative [comments] from people that have been promoting the opening of Cuba. Suddenly, they’re becoming more pessimistic about the ability of the current Cuban government to make the kinds of reforms that everyone seems to agree are necessary. By the [latest] Communist party assembly, back in April, less than 20% of plans and proposals approved a year earlier had been put into practice. It seems there are considerable obstacles.”

This is mostly because of the division of power and economic interest as the state loosens control of the economy, says Mr Hakim, as well as challenging technical issues, such as Cuba’s unusual dual currency and multiple exchange rate system.

Confusing currency

Cuban gross domestic product (GDP) currently stands at about $80bn at the official exchange rate parity. It would fall to $8bn at the government’s experimental rate of 10 pesos to the dollar and to just $3.5bn at the personal transaction rate of 24 pesos to the dollar, according to Stuart Culverhouse, chief economist at Exotics Partners, an investment bank that specialises in frontier markets.

“These figures don’t look realistic. We don’t have our own GDP estimate, but $30bn to $50bn may be more plausible, in our view,” he says. Official figures have GDP growing at an average of over 3% for the past five years, but a higher growth rate is needed to improve Cubans’ standard of living and the murky monetary system is hindering the process. According to data provider Trading Economics, Cubans’ average monthly salary is 687 pesos ($29).

The convertible peso, or CUC, is the currency that foreign visitors obtain in exchange of their notes, while Cubans are paid in the peso, the CUP – one of which is equal to about $0.04. However, state and foreign companies must exchange CUCs at a one-to-one rate with the peso.

The government's attempts to tinker with the exchange rate – the 10 pesos to the dollar rate – is being done to avoid shocks to the population and state finances, and resulted in Cuba’s sugar company, for example, receiving 1000 CUP, instead of 100 CUP, for every $100 of exports, allowing it to invest and pay workers more. Also, hotels that trade in CUC now charge one convertible peso per 10 CUP to buy local produce after the state-run tourism industry began buying food directly from farmers in 2013, rather than from state distributors or through imports.

CUCs are more commonly found in the local economy now. “It may be that in the end there is almost a natural displacement of the peso,” says Mr Hakim. Others believe the plan was instead to remove the CUC, which would have been accomplished months ago, all of which shows the enormity of the problem and technical challenges facing the Cuban government.

Private entrepreneurs

Nonetheless, much else has been done to improve the lives of Cubans, who can now supplement their income by using their homes as tourist accommodation or restaurants, for example. These retail sectors were not open to self-employment until a few years ago. According to the US Central Intelligence Agency’s World Factbook, there are about 476,000 so-called cuentapropistas, or self-employed Cubans, out of a population of 11 million. Reforms have also allowed private ownership and the sale of real estate and new vehicles.

Furthermore, the government has introduced the concept of small and medium-sized companies so that cuentapropistas can grow their business and employ workers, and it has been extending the same benefits granted in the Mariel zone to companies wishing to develop other parts of the county. The Central Bank of Cuba will also be supporting the new non-state management forms as well as foreign trade through financing by the banks it oversees, says the bank’s first vice-president, Irma Martínez Castrillón.

But with larger investment and capital flows comes the need for banking services to support transactions and trade. Several Canadian and European banks already have representative offices in Cuba and have been working with local banks for years, offering trade finance and transaction banking services to the country’s state-run lenders. Shandiz Godazgar, vice-president, emerging markets and strategic initiatives, at National Bank of Canada, one of Cuba’s longest standing foreign banks, is confident that its local business will grow in the future.

Confidence lacking

Following the lifting of barriers regarding Stonegate Bank, the credit card of Puerto Rico’s Banco Popular has also been allowed to function in the country. But despite progress to normalise relations with Cuba, and a few initial holes in the US embargo, the fear of sanctions still looms large on US investors and banks generally, while European lenders have been hit by blistering fines for failing to obey US rules. In 2014, the US courts fined Paris-based BNP Paribas $8.9bn for breaking sanctions against Cuba and other blacklisted countries. Last year, Commerzbank agreed to pay $1.45bn to settle similar allegations and separate charges.

Opportunities in Cuba are as inviting as the risks are a deterrent. Much progress is being made, but slowly and often in a seemingly opaque manner. Exposure to greater investor numbers can only help both Cuba and those companies looking for new opportunities. Once the US embargo is lifted, the future of Cuba and its new investors will undoubtedly look brighter – but while international firms might be able to wait, Cubans could be running out of time.

At the economists association in Havana, Mr Infante Ugarte does not have inside knowledge on US political workings but is convinced that sanctions will be removed soon. “We’re not going to see all the change we want in the next five years, but the US block will be lifted by then,” he says. “In five years, we’re going to see an improvement in peoples' lives.”

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Read more about:  Americas , Americas , Cuba
Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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