Unlocking Cuban Economic Renewal with Foreign Investment

By Roy C. Smith and Ingo Walter

The joint announcement by Presidents Barack Obama and Rául Castro last December about normalization of relations was an electric moment in both the US and Cuba. Since then, the buzz of excitement about what might happen next has been in full force - with many Cuban small businesses launched and a parade of important visitors from the US and other countries hoping to get in on the action as new investment and trade deals are negotiated.

Some people argue that a Congress unwilling or incapable of revoking the thicket of US trade and investment embargo legislation will allow others to leapfrog American companies in the most attractive sectors as the Cuban train picks up speed. This may be so, at least for a while. Florida’s Senator Marco Rubio, a Cuban-American contender for the Republican presidential nomination, has said “there is no way this Congress is going to lift the embargo”

But maybe the danger of losing out to the Europeans and Chinese is not so serious as the train, so far is only moving ahead in fits and starts, leaving plenty of chances to hop on later. But whether companies will want to will depend mainly on the seriousness and persistence of both countries’ reform efforts. So far, there’s not been much applause from the bleachers.

Formation of small businesses, and the purchase and sale of certain private property, had been authorized in Cuba well before the joint announcement last December. Since then, some government salaries for Cuban doctors and other professionals were raised, and Cuba has recruited a small bank in Florida to act for it in US dollar transactions.

Meantime, negotiations have begun on re-establishing embassies, but these are heavily politicized and slow going. The US has released some Cuban spies, and has dropped Cuba from a list of countries supporting terrorism. Mr. Obama has also announced some minor rules changes affecting American tourist visits - and allowing them to return with a few Cuban cigars. Mr. Castro attended the “Summit of the Americas” meeting in April, where he met with the President for the first time in 50 years. Mr. Castro has since met with the Pope, the President of France and other dignitaries, but without generating any important economic news.

A Cuban official recently spoke of a 4% target growth rate of the Cuban economy for 2015, up from 1.4% last year, in anticipation of more (as yet unannounced) market reforms and surge of tourists. However, the shaky Venezuelan economy, on which Cuba has long been dependent for handouts, is expected to contract by 6% this year, approaching “basket case” territory from which its ability to continue assistance to Cuba is doubtful.

There seems to be a consensus among informed Cubans that the motivation for economic reforms and reconciliation with the US comes from fears that the future of Cuban “Socialismo” is dim without Castro brothers to hold things together. Better to have limited reforms they can control than to have a fall into the jungle of market capitalism after they are gone.

So what should those limited reforms be?

Cuba’s economy remains backward and uncompetitive by almost any standard – most dramatically in agriculture, finance and the ability to attract foreign direct investment.

With large amounts of uncultivated land, Cuba still imports more than two-thirds of its food. Much of what is cultivated locally is still done “by hand” -  i.e., with oxen as the pre-1992 Russian tractors wore out and could not be replaced.  The limited foreign exchange earnings Cuba generates are mostly used for food imports.

Cuban banking, built on the old Soviet model, is especially backward. Most Cubans don’t have checking accounts, not to mention credit cards or access to loans. People queue weekly to withdraw small amounts of cash, and queue again to pay bills. No wonder Visa, MasterCard and foreign banks are so anxious to set up shop and secure first-mover benefits, transforming one of the last remaining virgin markets for financial services. But, so far, credit card usage is to be confined to foreigners.

Despite signals that it would like more foreign direct investment (FDI), Cuba has received remarkably little so far, largely because of difficulties on the Cuban side.  The Embargo prevents US FDI, but not direct investment from Europe, Asia or Latin America. There are questions about how profitable a market of 11.4 million poor people could be for goods or services produced in Cuba under local conditions in a joint venture with a Cuba state-owned partner.

All sizeable Cuban businesses continue to be owned by the state, so there will have to be privatization on the scale of East Germany in the 1990s, mostly in the form of sales to foreign investors since there is no Cuban capital market. For their part, investors appreciate a decent business infrastructure, property rights and a reliable legal system. None of these exist as yet in Cuba that are up to international standards even for emerging markets.

Reforming the FDI rules is the necessary first step. Without the capital and knowhow foreigners can bring, Cuba’s economic revival will be limited to the small-business sector, but that won’t be enough to pull the economy out of the deep ditch that 50 years of Socialismo has created.

Letting foreign agribusinesses into Cuba through direct investment is low-hanging fruit and an important opportunity. Not only should Cuba be able to feed itself, it ought to be able to produce ample surpluses for export to plug the drain on reserves.

Another good place to start is the Mariel Deepwater Port Project, a joint endeavor begun in 2009 with the Brazilian government, which contributed $800 million in financing. The project is still under construction. Cuba has awarded the contract for operating the port to a Singaporean company. There are scores of proposed foreign projects waiting approval. In the long run, a lifting of the US Embargo and the completion of the expansion of the Panama Canal will buoy the Mariel project. But it will still have to be competitive for transshipments with other Caribbean ports. For that to happen, Cuba needs to get much more aggressive in approving FDI proposals for Mariel that make economic sense. Perhaps this is starting. One of the world’s largest shipping companies, CMA-CGM of France, just signed a deal to establish a large logistics hub at Mariel.

The tourism sector offers yet another FDI opportunity. The Cuban buzz has already attracted many more tourists than before, but they are having trouble finding places to stay in. Most of the hotels are government run and dilapidated without much room or appeal. It would be both smart and easy to sell (or lease) the old hotels to European or Latin hotel companies to redo and then run. Some of this has already happened, although the latest trophy property is Havana is being developed by the Cuban Army. Meantime, Airbnb is hoping to sign up the adventurous and budget-conscious for vacations in Cuban family apartments.

Finally, beginning a long overdue effort to modernize the Cuban banking and financial sector has to be a high priority. Such an effort takes a long time, and will need much in the way of imported knowhow. Advice on modern central banking and prudential regulation is available from the World Bank and the IMF, even though Cuba is not a member of either one, or from the US Federal Reserve or the European Central Bank. All of these agencies should be willing to help, if asked, on the assumption that Cuba will join the IMF sometime in the future.

In the meantime, teaming up, for example, with an important Mexican bank to create a payments and clearing system for retail checking accounts, and developing a structure for credit facilities would be very useful. Even better, run a competition to charter 3 or 4 foreign banks and let them complete for the Cuban market – no need to reinvent the wheel – though the Castros may object to letting foreign banks gain a large share of the Cuban market.

 For years Cuba has blamed it’s lack of economic progress on the US embargo, but there is no embargo on FDI and trade with the rest of the world. The more Cuba moves to encourage diverse foreign investment from the rest of world, the more US companies will pressure Congress to lift the embargo.

It is asking a lot of Rául Castro to have a clear vision of the economic and financial system he wants to bequeath to the next generation of Cubans. Such things are hard to envision, even by experienced economists. But there has to be a starting point, as all the former socialist transition economies came to appreciate.

            Getting FDI right in the beginning will make more difference to economic rejuvenation than anything else Mr. Castro might do.