Doing Business in a Post-Fidel Cuba

Doing Business in a Post-Fidel Cuba
Pablo González AlonsoAlec Lee
DECEMBER 19, 2016

President Obama's historic visit to Cuba in March 2016 drove excitement
for businesses considering the market that the island could become. The
move made it possible to imagine an end to the U.S. embargo of Cuba
(which remains firmly in place) and a consequently sharp improvement in
Cuba's economic conditions.

However, in the subsequent months, Cuba has failed to advance on
economic liberalization, encountered a fiscal crisis, watched the U.S.
elect a potentially hostile president, and lost its revolutionary
leader. It's no longer clear whether Cuba will see either domestic
reforms or greater engagement from the U.S.

Understanding the policies that leaders in the U.S. and Cuba could
implement over the next two years will be critical for helping business
executives determine the level of urgency around developing their Cuba
operation.

A limited business opportunity
First, it is important to remember why Cuba still presents only a
limited opportunity for doing business. Cuba faces three overarching
challenges: The first is a lack of capital investment, which, in all
likelihood, is unsolvable without greater capital inflows to Cuba from
the United States, meaning the embargo needs to end. With a limited
financial system, Cuba lacks the domestic savings to raise fixed capital
investment above the current level of 10% of GDP (half the average of
Latin America).

Second, Cuba confronts the difficult task of unburdening its largely
stalled state-led economy. With many state-run enterprises dependent on
public subsidies, Cuba has attempted to shift workers to the much more
agile private sector, but progress continues to be slow.

Finally, Cuba confronts significant difficulties caused by its dual
currency system. In order to facilitate transferring subsidies to its
public-sector entities, Cuba utilizes two currencies: the convertible
Peso (CUC) valued on par with the dollar and fully tradable, and the
Cuban Peso (CUP) valued at a rate of 24:1 with the dollar. While useful
for exerting economic control, this mechanism serves to undermine the
competitiveness of Cuban exports and severely limits the purchasing
power of Cuban wage earners.

Without meaningful advancements on these three fronts, new business
developments in Cuba will simply not progress. While limited
opportunities will exist for companies in select sectors (such as
hospitality and telecoms), underlying economic performance will remain
flat, much as it has for the last several decades.

An economic crossroads
In April 2016, Cuba held its Seventh Communist Party Congress. At the
last Congress, in 2011, Raul Castro had announced plans to introduce new
market reforms and attract foreign investment. As such, many Cuba
watchers anticipated similar announcements in 2016, potentially
including instructions regarding the eventual elimination of the
country's dual currency regime. Instead, only limited new reform
measures were announced, and Fidel himself appeared to push back
somewhat against the general movement toward greater economic
liberalization.

Perhaps more important for an analysis of near-term Cuba policy, this
non-event took place in the context of an expanding fiscal crisis for
the Cuban government. Having long relied on subsidized oil imports from
Venezuela to provide cheap energy and the bulk of its foreign exchange
income, Cuba has seen its subsidized oil inflows dwindle as its
benefactor has entered into economic collapse. The result has been
periodic shutdowns of key public sector companies in Cuba, and blackouts
in Cuban neighborhoods.

In this setting, two distinct options are available to Cuban leadership,
depending on whether Trump will continue to advance economic and
diplomatic engagement with Cuba, or whether he will back away from the
country. In the case of the former, Cuba could continue down the path of
slow but steady liberalization, and in the case of the latter, it would
likely be pushed to retrench while seeking alternate sources of finance.
The first scenario would allow for continued development of already
existing business ventures and provide greater space for the U.S. to
remove the embargo; the second would likely result in limited new
opportunities within Cuba and continued economic stagnation.

An unpredictable U.S. President-elect
During the presidential campaign, President-elect Trump said that he
would revoke "the deal" with Cuba if he could not get more concessions,
such as the release of political prisoners or expanding the scope of
approved private sector business activities. Within a month after his
election, Trump had already hired two professed "Cuba hardliners" as
part of his transition team (Mauricio Clover Corone and Yleem Poblete,
who both support maintaining the Cuba embargo), possibly signaling that
he intends to hold hard and fast to his campaign rhetoric.

Despite these signs, due to expanding U.S. economic interest on the
island, which the Obama administration has worked hard to strengthen
before the transition of power in January, it would be difficult for
Trump to cancel all of Obama's policy changes toward Cuba. Rather, it
would be easier politically for Trump to seek some symbolic victory over
the medium-term (such as securing a win in Cuba for an American business
like Google), while largely maintaining Obama's policy changes. The
worst case for businesses interested in Cuba would be if Trump chooses
(or is forced) to retrench on Obama's key economic policy measures,
specifically the easing of travel restrictions and the licensing of
companies in the telecoms and financial services spaces.

How to know where the economy is heading
With these factors in play, the short-term outlook for Cuba is highly
uncertain. In that respect, companies can follow these key events to
better track the development of policy both on the island and in the
United States.

Does Trump pull the trigger on Article III of the Libertad Act of 1996
during the first 100 days of his presidency? The Act, passed in 1996 to
strengthen the U.S. embargo of Cuba, includes a provision, which, if
triggered, makes it possible to set off tens of thousands of lawsuits
against the Cuban government for property confiscated following the 1959
revolution. This would make trade with Cuba nearly impossible and likely
push back accelerated growth in Cuba by years, if not longer.
Does Cuba get a new economic benefactor? With Venezuela in free
collapse, Cuba is in a position to accept help from a new economic
benefactor. Potential support from either Russia or China could stave
off near-term economic contraction, while also potentially incentivizing
the Trump administration to end to the embargo in order to further
engage Cuba and avoid losing influence.
Do the Democrats add Senate seats in the U.S. mid-term elections in
November 2018? While there is a significant number of Republicans
who support ending the embargo, the Senate would likely require greater
Democratic representation to gain sufficient support for ending the embargo.
Does the new Cuban leader, who takes over in February 2018, accelerate
economic reforms? The new government will likely be the first not led by
a participant in the 1959 revolution, and it will need to draw a greater
portion of its legitimacy by driving economic growth and improving the
lives of Cubans. This would potentially push it to accept a greater
liberalization of the economy, including permitting greater private
activity and eliminating the dual currency system.
Pablo González Alonso is Director of Latin America Research at Frontier
Strategy Group (FSG), the leading information and advisory services
partner to senior executives in emerging markets. Access his latest
report, "Sizing the Cuban Opportunity."
Alec Lee is a research analyst at Frontier Strategy Group (FSG), the
leading information and advisory services partner to senior executives
in emerging markets. Access his latest report, "Sizing the Cuban
Opportunity."

Source: Doing Business in a Post-Fidel Cuba -
https://hbr.org/2016/12/doing-business-in-a-post-fidel-cuba