The recent death of Fidel Castro, the controversial revolutionary who ruled Cuba for nearly five decades, reignited fierce discussions about his socialist policies – which gave the country free healthcare and an effective education system on the one hand, and his authoritarian methods, irresponsible borrowing and an inherent distrust of the West on the other.
Despite these arguments, few people question the significance of this figure for the Cuban people and his role in the country’s history – even opponents of his politics are still mourning Fidel as a loyal and charismatic leader.
But as one historic era passes, it paves the way to a new future for a country that, for much of the 20th Century, had been the victim of an ongoing Cold War between the capitalist West and the communist Soviet Union.
“The death of Fidel Castro is of great consequence,” wrote Thomas Herzfeld, head of Thomas J. Herzfeld Advisors - an investment management firm that has maintained its presence in Cuba for over 20 years. “A new era is beginning for Cuba. We cannot change the past, but hope that now the private sector will grow in Cuba and people’s efforts will lead the country to a great future.”
Castro’s younger brother Raul is widely expected to step aside ahead of the 2018 election, so the potential leadership change has provided some cause for optimism. Outgoing US President Barack Obama’s restoration of diplomatic ties with the country last December, though, is a more significant development – one that was widely expected to bring Cuba back into the global economy.
The presidential decree did not automatically repair trade ties between the two countries, historically positioned on the opposite sides of the political spectrum. That would require the lifting of sanctions by the Republican-controlled US Congress – which, with the election of Donald Trump, looks increasingly unlikely.
Trump vs ‘Ruthless Dictator’
Trump has been highly critical of the ‘ruthless dictator’ Castro in his recent tweets, and in the past has indicated a plan to reverse the progress made by Obama in the relationship with Havana. But many see Trump as a pragmatic businessman, who would be lenient towards Cuba if he saw opportunities there for the US. His other contradictory statements indirectly confirm that notion.
“While Cuba remains a totalitarian island, it is my hope that today marks a move away from the horrors endured for too long, and toward a future in which the wonderful Cuban people finally live in the freedom they so richly deserve,” Trump said. “Though the tragedies, deaths and pain caused by Fidel Castro cannot be erased, our administration will do all it can to ensure the Cuban people can finally begin their journey toward prosperity and liberty.”
This sentiment is echoed by international economic experts. One analyst from an investment management fund told Bonds & Loans that, “Cubans consider Trump a pragmatist, who may cause some political disagreements, but could also help drive economic growth which is currently low.”
“Cuba and the US understand that in a negotiation both parties should give way to some extent. The Cubans say they will not yield one inch, but that is a face-saving attitude; in reality they know they must continue the discussion, as they have been discretely doing until now, maybe with even more intensity.”
Others, though, are less optimistic. "President-elect Trump can sway international markets with a swift stroke of a pen. Through executive order, the Obama Administration has lifted sanctions on Cuban-American banking relations; but on January 20th, Trump can just as easily close that window," investor Julian Rubinstein said in an interview with US radio show Money Talk Radio.
And there are major historical and economic stumbling blocks beside the relationship with the United States. Renegotiating outstanding debt with international lenders and restructuring a Soviet-style planned economy with strict capital and FX controls are problems that stand in the way of any major investment flows.
Throughout the last quarter of the 20th century Cuba’s economy survived largely on the assistance from the USSR, which consisted of trade credits, price subsidies, imports and other developmental aid. The collapse of the Soviet Union was predictably devastating for the Cuban economy.
And more recently the Island’s economy became increasingly reliant on ideologically-aligned Venezuela, particularly in terms of fuel imports and regarding the development of the Caribbean State’s own oil fields. The deflated oil prices in the last 3 years indirectly added more pressure on the ailing economy.
“Venezuela owes Cuba almost US$3bn, the oil supply has been reduced by 50%, and there are other issues, like the drop in Venezuelan investments in the Cuban oil refining and cement industries,” admitted the investment analyst, but insisted that although these factors are important, “they are not game-changing.”
From Russia, With US$32bn
The Cuban government for years refused disclose the levels of external debt and other economic figures, and it effectively became cut off from the international markets in 1986 after Castro declared a moratorium on commercial banks and western governments that lent Cuba money for development projects over the years.
Cuban bonds in default have spread far and wide, with some said to be framed, hanging on walls of traders and investors around the world, who at some point or another took the risk and got burned. Since 2010, trades of defaulted Cuban debt averaged US$13mn a quarter, down almost 90% from an average of US$100mn in 2009, according to data compiled by EMTA.
The government’s recent attempts to revive the economy and reprofile existing debt with international lenders culminated in an agreement with the so-called Paris Club countries at the end of last year. Under the terms of the deal, Cuba paid US$2.6bn in arrears in return for US$4bn of debt relief; another major milestone was persuading Russia to write off 90% of the Soviet-era debt worth a staggering US$32bn.
According to estimates by Moody’s Investors Service, Cuba’s current foreign debt, including bonds and loans, stands at about US$19bn.
“The situation of the previous debt default is almost completely solved. Cuba, after negotiations with the Paris Club, Russia, China, Mexico and many other countries, now has almost US$45bn less debt and much better interest rates (at an average 3 points less)” said the analyst.
But before the US, and other Western economies even consider bringing Cuba back into the market fold, the country’s new leadership will have to address some of the major challenges it is facing, and must take certain steps onto the path of economic reform.
Remittances to the Rescue
Some of these reforms were initiated in 2010, as the government eased some restrictions on self-employment and private ownership, allowing certain private business to hire workers, as well as expanding the range of professions open to entrepreneurship.
While wealthier residents make up only a small portion of the Island's 11 million residents, and are mainly concentrated in urban areas, their numbers are slowly increasing and this trend is expected to continue, and reach other parts of the country.
Notably, the economy is still heavily dependent on foreign funds: roughly 40% of Cubans living in Havana rely on pocket remittances. This money flow to Cuba grew by 15% per year from 2010, reaching about US$3bn in 2014, according to estimates by The Boston Consulting Group. By comparison, Cuba’s net exports stand at less than US$4bn.
“In the next 24 months, Cuban authorities will be going ahead with structural changes to the economy, including a bigger participation of private enterprise and the consolidation of the two existing currencies into one, being fully exchangeable,” noted the investment analyst.
“The biggest challenges for Cuba include the re-structuring of the labour system, improving its banking and insurance systems and opening up credit flow,” he added.
But investment managers like Herzfeld, who have persevered through the darkest periods in Cuba’s recent history, are now more optimistic.
“We believe and hope for the rapid growth of Cuba’s middle class, where many workers, both professional and blue collar, will have the potential to develop their own businesses, work in elected offices or in the private sector,” Herzfeld commented.
As for the possible return to the international bond markets, there are still outstanding debts to settle and issues with the US to sort out (namely with regards to crackdowns on opposition activists and amnesties for political prisoners). But here, too, the outlook is much better than a few years ago.
“We expect Cuba to return to the international bond markets, creating a secondary market for the remaining debt, for debt per equity exchange, and for participation with international FIs and corporations,” the investment analyst said.
In terms of the make-up of investors that could look to participate in a potential bond sale, the analyst expects to see quite a broad range.
“They are likely to be mostly mid-size direct investors in the tourism and industrial sectors, as well as, financial outfits of all types engaged in the tourism, industrial and agricultural sectors, such as nickel, cobalt, sugar cane derivatives, fertilisers, hotels and infrastructure construction,” he stated.
Admittedly, all of this is still some way off, and, as Rubinstein reiterates, “investors need to be cautious as relationships with Cuba continue to develop under a Trump administration." But irrespective of that, Cuba will need to finally turn the page and move forward, away from authoritarianism and government interference, and towards a free-market system, if it wants to be reintegrated into the global economy.
