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Patrolling
the Frontiers
As a
proponent of frontier investing we highlight economies in
transition that may present future opportunities. Today we
turn our attention to another part of the world...
CUBA:
Preparing for Perestroika
Dividing Old
Havana from Chinatown is Cuba's Capitolio Nacional, a monumental
edifice with a fateful past. El Capitolio was conceived
during the "Roaring Twenties", when the island led the
world in sugar exports and the future seemed blue-sky.
President Gerardo Machado, who dreamed of turning Cuba into the
Switzerland of the Americas, decided that his four million
countrymen needed a domed Capitol building even taller and more
ornate than the one he toured in Washington. Cuba's
Congress dutifully poured 3% of the country's GDP into their new
home (akin to the US Congress spending $42 billion for a new
office today, but let's not give them any ideas...) It took 5,000
skilled Cuban laborers just three years to complete El Capitolio,
which featured gilt ceilings, a giant diamond embedded into the
pristine marble floor, and the world's third-largest indoor
statue. However, the showy project couldn't have been more
poorly timed: while the building rose, America's stock
market crashed, the Great Depression unfolded, and the
Hawley-Smoot tariffs crushed Cuban sugar prices by 74%. As
El Capitolio's ribbon was cut in 1932 Cuba's economy lay in
tatters, with two-thirds of its citizens thrown into
destitution. Machado was forced out of office, and his dream
building would perform Congressional service for only 27 years
before Fidel Castro's revolutionaries swept into Havana and opted
for more austere premises.
Fidel Castro
would go on to lead Cuba for almost five decades, doggedly
clinging to socialist dogma, even after the Berlin Wall collapsed
and other surviving communist states embraced market-based
economies. Castro's achievements included delivering to his
people free health care and education, as well aslow cost
housing, transportation, sports, culture, and daily
essentials. Cuba is one of the few countries in Latin
America free of narcotics gangs and street criminals, and where
large contracts are awarded without kickbacks. Cuban
athletes excel at a multitude of sporting activities from boxing
to baseball, and Cuban scientists routinely invent new
vaccines. But at the same time, just as single party
rule has deprived Cubans of political freedom, Marxist
central-planning has starved them of economic advancement and the
country finds itself with well-educated and healthy citizens
plowing fields with oxen, or driving horse carts down empty
highways.
Now,the winds of change are
gathering in Cuba, carried by both economic necessity and
political transition. Since Fidel Castro's health nearly
failed in 2006, power has passed to his younger brother Raul
Castro, who is showing greater assertiveness and organizational
prowess as he approaches his 80th birthday. Raul
has quietly reshuffled more than 30 Fidel-appointed cabinet
members to prepare his Party and people for a sweeping economic
policy overhaul-Perestroika al Cubano. Even the
semi-retired Fidel seems to have glumly accepted that change is
inevitable, candidly admitting to a visiting US journalist that
"the Cuban model doesn't even work for us in Cuba
anymore".
For nearly five decades, the
United States has been trying to hasten Cuba's need for change by
restricting most US nationals from investing in, trading with, or
even visiting the island nation just 90 miles away.
While this policy has imposed severe hardship on the Cuban
people, it has also provided Cuba's Communist Party with a handy
political excuse for policy failures, thereby helping sustain the
Party's popularity, which even today appears to be
solid. The US Trade Embargo's visible result is a
Cuba that appears frozen in the 1950s: patched up cars, obsolete
power plants and factories from that era still in use today.
A masterful crisis manager,
Fidel Castro was adept at papering over economic rot with other
people's money. Shunned by Washington for nationalizing US
assets, Castro's Cuba became a Soviet client state, reaping
billions of dollars worth of annual subsidies. After the Berlin
Wall fell, Cuba reopened its tourism industry and legalized US
dollars to encourage inward remittances. When leftist Hugo
Chavez gained control of Venezuela, Fidel talked him into
swapping 100,000 subsidized barrels of oil per day for 20,000
underpaid Cuban medics, generating substantial profits for
Cuba. Castro also took out $4 billion of loans from China
to finance purchases of that country's goods.
The global economic crisis
whacked Cuba hard, however. Venezuela cut back on its
largesse as its own economy worsened. Tourism and remittances
softened, while nickel export prices tanked. Furthermore,
three severe hurricanes left a wake of destruction in 2008.
Unable to service Cuba's estimated $21 billion foreign debt, and
running out of generous leftist patrons to hit up, Raul Castro
has apparently decided he has little choice but to pry open
Cuba's economy and try to entice the U.S. to normalize
relations. Barack Obama seems tempted.
Castro's wild card is Cuba's
oil and gas reserves. The island currently produces 60,000 bbl a
day, but its US-facing northern waters are estimated to hold an
estimated 5- 20 billion bbl of oil and 20 trillion cf of natural
gas. (Note: this compares with 29 billion bbl of oil
reserves in the entire US.) Accessing this undersea oil
requires the sophisticated drilling technology the US excels in,
but as long as sanctions remain in place, the US oil majors are
excluded from that bonanza. Amidst the applause of oil
industry lobbyists, the dance for reengagement has begun, with
both partners taking some unprecedented steps.
Obama set the stage by
publicly admitting the US embargo of Cuba has been a failed
policy. He then made it easier for Cuban-Americans to visit or
remit money to relatives in Cuba, while improving linkages of
internet and television. The US Congress is discussing a
bill to end the travel embargo altogether, and, in the meantime,
the ban has just been relaxed for students and other specified
groups. There is already considerable interaction between the
U.S.and Cuba: US companies export $500 million of food and
medicine yearly to Cuba, while charter flights run back and forth
between Miami and Havana. The US and Cuban navies
reportedly sit down monthly for cordial meetings.
Cuba has eased tensions by
releasing around one third of its political prisoners to Spain
via the Catholic Church. Raul Castro has issued a
far-reaching five-year roadmap for Cuba's future economic reform
and development, which will be tabled in April 2011 at the
upcoming Sixth National Congress of the Communist Party, the
first such gathering since 1997. The proposed changes
would put Cuba on a very similar path to that taken by China in
the 1980s and Vietnam in the 1990s. Here are some of the
ideas: permit real estate transactions amongst Cubans,
mergethe two-tier currency system, closedown inefficient state
enterprises, decentralizestate ownership, facilitate private
ownership of businesses, distributeidle land to farmers, open
state-owned wholesale markets, and further encourage foreign
investment - particularly in tourism.
In recent months, some
planned reforms have already been implemented in an effort to
delay Cuba's impending insolvency. Costly subsidies on
sugar and personal care products are being scaled back. The
government announced plans to shed 1.3 million state workers
(that's more than 25% of the workforce - more than 11% of the
entire population!) and guide them somehow into the private
sector. Cubans are being encouraged to grow and sell their
own fruits and vegetables. The government is inviting
foreign investors to develop 10 golf course estates in Cuba, with
a new law allowing 99-year land leases to foreign buyers of plots
in such projects. In the old days of Fidel's Revolution
such policies were unthinkable.
So what is the potential for
a liberalized Cuban economy? Just look 90 miles across the
Straits to Florida, where one million Cuban-Americans call
home. Cuba has 60% of the Florida's population and 80% of
its landmass, but greater natural resources and a much longer
coastline, so one might conclude that the two are of comparable
overall potential., Perhaps to underscore their similarities,
remember the fact that England and Spain cleanly swapped the two
in 1763. Today, Florida's economy is 12 times larger than
Cuba's. One reason is that Florida gets 20 times as many
tourists as Cuba, plus an inflow of affluent retirees. When
the US Government stops restricting its citizens from traveling
to Cuba, the island will become an instant tourist magnet.
Offering short flights, sunny beaches, cool music, "old
world" architecture, and cheap surgery. Cuba should have no
problem drawing several million American tourists a year as
further away destinations like Costa Rica have done.
Should reforms become
comprehensive enough, agriculture seems an obvious investment
play: half the land is arable, labor is cheap and rain
plentiful. Cuba's once-vaunted sugar industry stands in
disarray with 80% of the old mills shut down, but today's high
sugar prices provide ample incentive to revive the sector, along
with other traditional crops such as cigar tobacco. Despite
its long coastline, fisheries and aquaculture remain largely
overlooked. Cuba is a world-class producer of nickel but other
mineral deposits remain underexploited, and then there's the
oil. The entire power system needs to be updated, financial
services developed, retailing expanded - the opportunities seem
endless.
Cuba's demographics are a
cause for concern, however. With a median age of 40, the
population has already peaked at 11 million and faces decline
unless immigration is promoted. Over 70% of Cuba's people
have lived their entire lives under paternalistic socialism and
lack the training, experience and capital to start private
businesses. Supporting Cuba's future retirement population will
be a big challenge given the challenge Cubans have to accumulate
savings: 85% hold government jobs paying $20 per month, and
were not allowed to own their homes. In addition, Cuba is
not a cheap place to live. Beyond the subsidized basics, most
consumer goods have to be imported, and imports draw heavy
duties. Telecom services are costly due to government
monopolization and inefficiency. The list goes on. In
this environment it is tough for most Cubans to get by unless
they receive remittances, tourist gratuities, or tea money.
All in all, we eagerly await
the implementation of Cuba's economic reforms, the gradual
normalization of its economy, and the eventual restoration of its
relations with America. As this process unfolds Cuba could
transform into one of the world's most attractive frontier
investment destinations. America has a long track record of
turning bitter rivals into productive partners (a recent example
being Vietnam), and re-engagement with Cuba could be one of
Obama's most notable foreign policy legacies.
Some frontier investors are
not waiting for that and are already investing in Cuba.
While 100% foreign ownership is permitted, most investors enter
joint ventures with Cuban state enterprises which typically
contribute land, labor and sometimes capital. Over
250 such joint ventures exist, mostly for specific sectors or
projects. Investments are made in foreign currency,
eliminating exchange rate issues, and there are no restrictions
on capital repatriation. Corporate income tax is 30% for
joint ventures, and 35% for wholly-owned foreign companies, but tax
holidays of 5-7 years are available to facilitate investment
recovery.
A few Cuba-focused
investment groups have been established that non-US investors can
access. Canada-listed Sherritt Group is a major player in
Cuban nickel mining and, formerly, telecoms. A private
investment group backed by European investors, Coral Capital has
restored Havana's historic Saratoga Hotel, which was recently
ranked by Conde Nast as the 16th best hotel in the
world. Coral is now planning a number of golf course, marina,
housing and hotel projects, as is Leisure Canada, a Canada-listed
investment vehicle.
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