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    In Cuba, a Potential for Prosperity

    In Cuba, a Potential for Prosperity
    Analysis AUGUST 5, 2015 | 09:15 GMT Print Text Size

    Forecast
    – Cuba and the United States will continue to strengthen political ties
    in the coming months and years.
    – In the short term, Cuban tourism revenue could increase and certain
    financial restrictions ease, but the country may still feel the impact
    of Venezuela’s economic downturn.
    – In the longer term, the impact of the Cuba’s opening will
    depend on Havana’s ability to address structural issues in its economy
    and on when and how the United States decides to lift the trade embargo.
    – The Cuban government will likely introduce reforms gradually and
    selectively to take advantage of economic opportunities while
    maintaining a firm grip on political power.

    Analysis

    Cuba has been shunned for so long that it is easy to forget just how
    important it is to the United States. The island nation has a prominent
    position at the mouth of the Gulf of Mexico, separating access to the
    gulf into two chokepoints: the Yucatan Channel and the Straits of
    Florida. Cuba is also situated on the sea-lanes between the U.S. East
    Coast and the Panama Canal, the shortest route for naval traffic between
    the two coasts of the United States. Cuba, which lies just 145
    kilometers (90 miles) off the coast of the United States, has thus been
    pivotal to safeguarding economic activity in the Gulf of Mexico and
    naval transport routes beyond that. When the United States and Cuba are
    on opposing sides, the U.S. imperative is to try and neutralize and
    counter foreign support to Cuba from more powerful sponsors interested
    in meddling in the United States’ backyard. If Cuba is on friendly terms
    with the United States, this task becomes all the more manageable.
    In terms of Cuba’s own economy, it has historically been driven, like
    many Latin American countries, by the production and export of raw
    materials. Cuba’s most important resources have traditionally been sugar
    and tobacco, although the country is also a significant producer of
    nickel and hard alcohol. However, in large part because of its strategic
    location and interest from external powers, Cuba has experienced a
    unique political and economic trajectory over the past six decades.

    The Cuban Revolution of 1959, led by Fidel Castro, dramatically shifted
    Cuba’s economic structure from a capitalist economy integrated with that
    of the United States to a socialist, centrally planned economy oriented
    toward the Soviet Union. With Castro’s revolution came
    the nationalization of the Cuban economy, sweeping land reforms and
    radical wealth redistribution. The Cuban government took control of
    virtually all major economic activity in the country, even to the point
    of confiscating foreign — and particularly Western — businesses
    operating on its soil, including the extremely powerful U.S.-based
    United Fruit Company. At the same time, the new Cuba became closely
    dependent on the Soviet Union for key goods such as oil and food.

    With the collapse of the Soviet Union in 1991, Cuba lost one of its
    major economic patrons. The highly subsidized oil shipments it had been
    receiving from Russia fell 86 percent from 1989 to 1992, and food
    imports from Russia dropped more than 40 percent in the same period.
    These factors, along with a major drop in sugar prices, provoked a major
    economic recession in Cuba in the early 1990s, which in turn sparked
    some important reforms to the Cuban economy: Fidel Castro’s government
    opened the country to tourism and limited foreign investment,
    while semi-legalizing the use of the U.S. dollar.

    Nevertheless, Cuba still remained largely closed off to the United
    States, which retained a trade and travel embargo on the island. Cuba
    eventually found a new economic patron in Venezuela, whose left-wing
    government under President Hugo Chavez began sending subsidized fuel
    shipments to Venezuela as the Soviet Union had done. Even with
    the political transition from Fidel to his brother Raul Castro in 2008,
    when Cuba began engaging in some limited economic reforms such as the
    legalization of informal business activity, the state continued to play
    a dominant role in an economy that remained largely closed off to
    the United States.

    A Diplomatic Opening: Short-Term Effects

    The death of Hugo Chavez in 2013 and rising political and economic
    instability in Venezuela over the past two years have once again
    endangered Cuba’s primary economic patron, which in part explains the
    latest major development trend in Cuba’s political and economic
    evolution: renewed diplomatic ties with the United States. Beginning in
    late 2013, there were signs of a warming between Cuba and the United
    States, including a handshake between U.S. President Barack Obama and
    his Cuban counterpart, Raul Castro, at a memorial service for Nelson
    Mandela, and the start of bilateral talks in 2014 over various
    issues, such as the U.S. embargo on imports from Cuba and the use of
    Guantanamo Bay.

    These talks culminated in a major breakthrough in December 2014, when
    Cuba released former U.S. contractor Alan Gross in exchange for three
    Cuban spies who had been held in the United States. Shortly thereafter
    officials from both countries announced high-level political discussions
    focused on renewing their diplomatic relationship. Then, in March 2015,
    the U.S. Office of Foreign Assets Control removed dozens of Cuban
    companies connected to tourism and shipping from the sanctions list. On
    July 1, Obama finally made the official announcement that the United
    States and Cuba were to re-establish diplomatic ties and eventually
    reopen embassies in Havana and Washington.

    Washington has also loosened economic restrictions to allow more money
    to flow into Cuba. Americans currently send $2 billion to Cuba in the
    form of remittances each year, but new changes allow individuals to send
    up to $2,000 per quarter to family members in Cuba, up from $500 per
    quarter previously. In addition, U.S. banks can now process credit card
    transactions from Cuba, a move that enables Americans who travel to the
    island to use their credit and debit cards.

    Thanks to the diplomatic thaw, the Cuban tourism sector is on the
    rise. Tourist traffic to the island is up 15 percent compared with the
    same period last year, with around 1.7 million people visiting in the
    first five months of 2015. Moreover, each of the first five months has
    seen a double-digit increase in visitors — many of whom are coming from
    the United States. For May that number jumped 21 percent. Perhaps not
    coincidentally, Cuba’s economic performance in the first half of 2015
    registered a growth of 4.7 percent, which shows a reversal of the
    downward trend between 2013 and 2014. Now Cuba’s economy is projected to
    grow 4 percent this year, largely driven by the construction and
    agriculture sectors. That is almost four times its growth rate in 2014,
    the fastest climb Cuba has seen since 2008. Even if economic statistics
    out of Cuba are not always completely reliable, they can still help
    paint a general picture of the country’s prospects for growth.

    The Long-Term Outlook

    The next few years may be promising for Cuba’s economy. The island has a
    highly literate population, relatively cheap labor, abundant population
    and natural harbors. Cuba also has a small but promising biotechnology
    sector with the significant potential for medical and drug
    manufacturing. Indeed, many international pharmaceutical companies
    already having identified Cuba as a potential site for drug making.
    There is also potential for Cuba to serve as a transshipment
    hub, contingent on upgrades and expansions to the country’s ports.

    But despite these factors and the initially positive economic signs amid
    the thaw between Cuba and the United States, the imbalances created by
    five decades of economic isolation will constrain Cuba’s long-term
    economic growth. The Cuban government remains by far the largest
    employer on the island, and state-owned exporting businesses (as well as
    limited joint ventures with foreign firms) are highly inefficient
    compared with foreign competitors. Cuba’s two-tiered currency exchange
    rate — in which a convertible peso is pegged to the dollar and used for
    foreign trade and the tourism industry, while the local peso is used for
    local goods and for paying local wages — is also problematic and
    dissuades foreign investment. Moreover, the country’s restrictive
    foreign investment law, which taxes foreign-owned firms heavily and
    limits international arbitration to settle disputes, is a major drag on
    foreign investment.

    The Cuban government does have plans to have a legal draft in place for
    the unification of the dual currency rates by sometime in 2016, but the
    pace of Cuba’s opening to foreign capital will in large part depend on
    whether the United States actually ends the Cuban trade embargo within
    the next few years. According to U.S. law, Congress has to see a
    transitional government in place in Havana before it has the authority
    to amend or annul the ban on trade with the island. With Cuban President
    Raul Castro set to step down in 2018, the United States could wait until
    then to see if Cuba meets the legislative criteria to lift the embargo.
    A second option, promoted by some members of the U.S. Congress from both
    sides of the aisle, is for Congress to amend the law underpinning the
    embargo, thereby removing the legal rationale for maintaining the ban.

    Even if Congress does lift the embargo, Cuba must manage its internal
    structural problems, including a monetary policy divorced from trade,
    poor energy and transport infrastructure and lack of capital stock — all
    of which limit its economic growth. In the coming years, Havana will try
    to address these issues but take care to keep those economic reforms
    from undermining its strong grip on power as the presidency transfers
    from Raul Castro to First Vice President Miguel Mario Diaz-Canel Bermudez.

    Given the tenuous political situation, Havana’s reforms are likely to be
    measured and gradual, and certain structural issues may impede the
    process. Cuba nevertheless has the potential to become an attractive and
    competitive low-end and middle-end manufacturing environment and see
    strong economic growth in the wake of its opening with the United States.

    Source: In Cuba, a Potential for Prosperity | Stratfor –
    https://www.stratfor.com/analysis/cuba-potential-prosperity