A New Chapter for Cuba-US Relations

There has been a lot of excitement recently about what appears to be a new chapter in Cuba-US relations, including the possible restoration of diplomatic ties between the countries and the end to decades of US sanctions. I’ve always been quite interested in Cuba since my family on my mother’s side came from one of Cuba’s Caribbean neighbors, Puerto Rico. Although I’ve been to Puerto Rico a number of times, I’ve been to Cuba only once in 1995, when I flew to Havana as a guest of a Mexican businessman who was working to operate a telecommunications company in the country. The perplexity confronting Puerto Ricans about whether they should be an independent country, a state of the United States of America or one of its territories (what they are now), is symptomatic of the attitudes of many Cubans. On the one hand, there is a love of US culture and products, but on the other hand, there is a desire for independence and preservation of Cuba’s unique Latin culture. Under US President Theodore (Teddy) Roosevelt, the United States helped liberate Cubans from the Spanish colonial administration. However, the euphoria and gratitude was later destroyed when the United States supported a corrupt administration under Fulgencio Batista, which was overthrown in the Communist revolution led by Fidel Castro.

Many Cubans now living in the United States feel conflicted about the situation, which I think was beautifully portrayed in Tom Wolfe’s book, Back to Blood. My own visit to Cuba was quite an experience! The Cuban people were so kind, friendly and incredibly musical. When I asked individuals at the hotel where I was staying to recommend a restaurant, I found it strange when they told me that there actually were no restaurants outside the hotel since such private businesses were not allowed. Instead, they said they could recommend a home where I could eat with a Cuban family. I learned that people were essentially operating restaurants from their homes, which did not violate the law as long as only the family served and cooked the food, and they did not have more than a certain number of tables for guests. I thus had the good fortune to dine at a Cuban home that operated just like a small restaurant and served wonderful food.

Another interesting experience I had in Cuba took place while on my morning jog on the esplanade along Havana’s ocean coast. A large vehicle passing by on the road honked its horn, and a gentleman called out to me by my name. You can imagine my surprise to find it was the head of a Canadian company investing in a variety of businesses in Cuba who had recognized me. He got out of the car, and we chatted for a while about the sanctions preventing him from entering the United States because of his company’s operations in Cuba. Nevertheless, he seemed to be quite uplifted by Cuba's potential.

Now that relations with the United States are thawing, I think there are new reasons to be optimistic about Cuba. At the beginning of this year, the US government sent a high-level delegation to Havana, Cuba's capital, led by US Assistant Secretary of State for Western Hemisphere Affairs Roberta Jacobson to hold talks with Cuban officials. Although the United States and Cuba have been having some contact for a number of years, this time there are great expectations for an eventual normalization of diplomatic relations between the countries. And, it appears most Americans support these efforts, according to a recent Pew Research Center poll.

The US State Department has conveyed that the United States aims to lift restrictions on travel, commerce and financial activities with Cuba. However, with a Republican-controlled Congress and a strong anti-Castro Cuban diaspora still holding sway in the United States, it seems unlikely that rapid progress will be made unless there are more signs of democratic reforms in Cuba. Nevertheless, it seems obvious there will be some opportunities for airlines to increase flights to the island following relaxed travel—and we’ve already heard that message from a few US carriers eager to service or expand existing charter services to Cuba. US banks could also benefit since US tourists visiting the island will be allowed to use credit and debit cards issued by US banks, and US bank accounts of Cuban citizens living on the island will be unlocked. Remittances from the United States to Cuba are being raised from a maximum of US$2,000 to US$8,000 annually, but unless the 1962 embargo instituted by US President John F. Kennedy is lifted, foreign investment from the United States into Cuba will remain severely restricted.

Liberalization of Trade in Cuba

The Castro government's tight grip on the economy remains an additional barrier to wider investment, but there are some signs it could loosen. Despite President Raul Castro’s initiation of economic reforms in 2008—which allowed limited private ownership and foreign investment—the government remains involved in nearly all economic sectors as a means to fund government expenditures.

Food could be the first item of trade to be liberalized in Cuba. A US Agriculture Commission for Cuba including about 30 US companies and food-related groups headed by an executive of a US food giant has been lobbying the US Congress to lift the trade embargo with Cuba and ease trade sanctions. Currently, some food exports from the United States to Cuba are allowed on humanitarian grounds. Cuba imports about 80% of its food requirements, valued at about US$2 billion a year, but the United States’ share is only about US$250 million.[1] The US farm lobby would thus like to increase its market share.

Currently, the Communist government in Cuba owns at least 50% of all foreign ventures and also receives a substantial percent (often over 90%) of what foreign enterprises pay Cuban employees. Some foreign firms are already in Cuba and could benefit from liberalization. For example, a European company has a minority stake in the Cuban government-controlled company that produces Cuba’s famous cigars. Now, American tourists will be able to bring home US$100 worth of those cigars under the new rules.

Despite general restrictions for US tourists, some 400,000 Cuban Americans travel yearly to the island to visit relatives. They usually bring gifts such as electronic appliances, TV sets, mobile phones, personal computers and such, which often find their way into a thriving black market. New regulations on Cuba’s side will restrict such imports impacting hundreds of products. Not only is the purpose to restrict the black market, but also to limit Cubans’ access to the global Internet, which could lead to demands for more political reforms—in spite of a countervailing push by many US high-tech companies to broaden access.

In my view, the impact on US firms of the new relationship with Cuba will likely be limited, at least in the short to medium term, but the gains for non-US firms could be substantial. I think Cuba’s ability to access the US market could make investing in export-oriented Cuban enterprises more attractive. If the embargo were to be lifted, then Cuban companies that escaped to the United States after the revolution could return and relocate there.

Additionally, a US$900-million Mariel port development project built by a Brazilian construction company with financing from The Brazilian Development Bank (BNDES) is putting Cuba in a good position to be a transshipment port as well as a more attractive cruise ship destination. The port is to be operated by PSA International Pte Ltd (formerly Port of Singapore Authority), and the Mariel free trade zone surrounds the port. Implementation of the Cuban Law on Foreign Investment should offer significant benefits (including tax exemption on profits for eight years) for foreign investors who partner with Cuban state-owned enterprises. I think it’s also important to note that there already are more than 400,000 estimated [2] small, Cuban, privately owned companies called “cuentapropistas,” including those family-run restaurants called “paladares” that I enjoyed on my first visit to Cuba.

In 2011, Cuba's Sixth Congress of the Communist Party introduced over 300 economic guidelines to widen the private sector, including a reduction of state workers by up to 1 million of the total Cuban government workforce of about 5 million.[3] Since both self-employment and the hiring of workers privately have been prohibited, it will be necessary to issue self-employment licenses to the private sector to absorb this workforce; the first licenses were handed out early in 2011.

The falling price of oil is a development that I believe could encourage the Cuban government to move faster in regard to reforms. Venezuela’s program of subsidized oil exports to Cuba and other countries is under threat today as oil prices have declined significantly over the past few months. The Venezuelan economy is in trouble, and it is doubtful that the government can continue the subsidy program if global oil prices remain depressed. Since Cuba consumes more than 150,000 barrels of oil per day, of which two-thirds are now coming from Venezuela,[4] the prospect of reduced supply from Venezuela will make imports of oil from the United States more attractive to Cuba.

Probably one of the major hurdles confronting foreign investors is Cuba’s dual currency system. The government has announced its intention to eliminate it, but no action has thus far been taken. Under the system, there is the peso (CUP), used by Cubans, and the convertible peso (CUC), used by foreign tourists and businesses. While the CUC is pegged to the US dollar at 1:1, the CUP is valued at 1:25 to the CUC. The government collects the difference as essentially a tax on foreign visitors and businesses. Foreign business operating in Cuba must hand over local-employee wages to the government at a dollar-to-peso rate of 1:1 while the workers are paid only at 1:25, with the government collecting the rest.

Despite the obstacles, we think the long-term opportunities for potential investment in Cuba look enormous. While exact figures for foreign direct investment (FDI) are difficult to pin down, they are believed to be much lower than even its smaller Caribbean neighbor, the Dominican Republic, which attracts over 20 times more—about US$17 billion FDI—of which about US$2 billion is from the United States.[5] As Cuba liberalizes and establishes better relations with the United States, we can see exciting prospects in Cuba.

Mark Mobius’s comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The information provided in this material is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding any country, region market or investment.

Data from third party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional advisor for further information on availability of products and services in your jurisdiction.

What Are the Risks?

All investments involve risks, including possible loss of principal. Foreign securities involve special risks, including currency fluctuations and economic and political uncertainties. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets.

__________________________________________________________________

[1] Sources: US-Cuba Trade and Economic Council, export statistics for the period of Jan-November 2014. World Food Programme, www.wfp.org/countries/cuba, United Nations Development Programme.

[2] Source: Brookings Institution, “Soft Landing in Cuba?” November 2013.

[3] Sources: Brookings Institution, “Soft Landing in Cuba?” November 2013; Sixth Congress of the Communist Party of Cuba, Resolution on the Guidelines of the Economic and Social Policy of the Party and the Revolution, April 18, 2011.

[4] Source: US Energy Information Administration, 2014.

[5] Source: Office of the United States Trade Representative, 2012 (latest data available).