Viva Cuba, viva ‘the free market’ revolution

Right on the Money

Without much noise, Cuba is embarking on a second revolution. A lot has happened since Raul Castro replaced his brother Fidel as Cuban head of state in February 2008. As our capitalist world was fighting for it’s survival during the great recession Cuba was busy with problems of its own; huge trade deficits, difficulty to raise capital, increased dependency towards Venezuelan oil and more. Lets face it, it was not going to be an easy survival for the small socialist state when faced with the collapse of the global tourism industry together with the isolation caused by the 52 year old US embargo.  

Raul Castro is less well known to many. Contrary to his brother he has never asked for the spotlight and came to power as Fidel’s health declined. Raul is no spring chicken, marking his 81st birthday in early June this year. He appears to be in good health and presents no signs of serious physical illness. When Pope Benedict XVI visited the island in March and met with both brothers, Raul was reported as the most spry and energetic of the three octogenarians. With Fidel looking his years, and Cuba’s top patron, Venezuelan President Hugo Chavez, battling cancer, Raul’s health is especially crucial to the country’s future as no heir apparent is emerging.  

So why would we be bullish toward Cuba’s economy under the continued leadership from the first revolution? Well, for an indication of what the future hold, look at the recent history of reforming socialist economies such as China and Vietnam. Raul has already engaged the economy into changes that, I believe, will be irreversible going forward. Like a snowball growing and gaining speed as it rolls down the hill, the liberalisation of the Cuban economy is gaining momentum. Raul has started the second revolution and the people will continue it, who ever leads them going forward. 

Over the last few months many changes have affected the lives of 11 millions Cubans. The most revolutionary are: 

Cubans can now own and operate small private businesses 

Cubans can now own property 

Cubans can now own, buy and sell vehicles 

Cubans can now borrow money at approved financial institutions. 

As you can see, Cuba is making important changes to its policies with the legalisation of private ownership and the emergence of small business credit. The Cuban government aims to move 1 million workers off state payrolls and towards private enterprise over the coming years. Cuba needs the liberalisation of its economy to achieve this goal. Such an achievement would phase out rationing and unify the official and parallel exchange rates. Implementing these policies would unlock enormous economic potential.  

Today’s period will be remembered as the first stage of the emergence of a free market in Cuba. Like China in the eighties, Cuba is turning toward a liberalised market under the supervision of a central government. That being said let’s be real, Cuba is no China yet, capital is lagging, technology archaic and the US embargo continues to make global trading cumbersome to say the least. We are still many years away from a market economy based on supply and demand without government interference.  

Changes bring changes and more policies are now getting drastically modified. Over the next few months we expect the Cuban government to announce an important reform for Cubans travelling to foreign countries. As mentioned in the New York Times recently: “If it does become easier for Cubans to legally leave the island, the reform could spur economic migration and deepen ties between the island and the 2 million members of the diaspora, whose money and business experience may be vital to the government’s plans to enlarge the private sector.” Goodbye boat people. If you think about it, the Cuban economy would do much better with one million fewer mouths to feed. According to Arturo Lopez-Levy, a Cuban-born academic who left the island 10 years ago and lectures at the University of Denver: “If you have a significant change to the migratory law, it will be a watershed. It could unleash the potential of the whole reform programme and it could empower the actors who favour reconciliation between the Cubans on the island and the diaspora.” When we add to the mix of the reform the financial impact of an increased number of Cubans living abroad and sending money home it is not difficult to realise that going forward the economy will be tilted toward growth.  

The economic future of Cuba is full of potential and already today the country shows important growth within the following industries: 


Healthcare industry 

The Cuban healthcare system is respected around the world and is literally decades more advanced than any system found in Latin America. For this reason the Cuban system serves as a model for third world developing nations. Cuba stands out statistically as well. Its infant mortality rate of 5/1,000 is second to none in Latin America, and is near that of the United States. The life expectancy of the average Cuban is also far longer than that of people in any other Latin American country. 


Oil industry 

Cuba estimates its offshore oil reserves to be at a minimum of 20 billion barrels (the U.S. has reserves of 29 billion barrels.). “If it really is 20 billion, then it’s a game changer,” says Jonathan Benjamin-Alvarado, an oil analyst at the University of Nebraska-Omaha. Cuba’s achilles heel is its dependence towards foreign energy. If, as expected some important reserves are discovered going forward, this would positively alter the state of the economy.  


Tourism industry 

Tourist arrivals have been consistently rising over the recent years despite the global downturn. For the fourth consecutive year Cuban tourism had a record number of tourist visits in 2011. Furthermore Cuba benefits from the diversified geographic origin of its tourists, from Europe, Canada and many emerging markets such as Russia, Chile and Brazil. Moreover, the trend should continue going forward as the probability of a normalisation of the country’s relations with the US is increasing. Cuba may soon become the new go-to destination for millions of American tourists in years to come. 

The economic future of Cuba appears bright, it does present risks but when compared to most Caribbean nations or highly in-debited developed countries, the potential is far more interesting. As an example, Cuba’s debt to GDP is expected to be 32.7 per cent for 2012, half the debt level of the US, one quarter of the debt to GDP of Jamaica and Barbados and close to one third of the debt level of Canada.  


How to invest in Cuba 

The question for most investors is how can I participate in such a market? There is no stock market in Cuba and at present time ownership of property is limited to Cuban citizens. An interesting approach is to invest in Cuban trade finance assets. Cuban trade finance assets are payment obligations evidenced by negotiable trade finance instruments such as deferred payment letters of credit, bills of exchange and promissory notes payable at future date. They are issued by Cuban banks and non-financial corporations in favour of suppliers of goods or services. In some cases, a local bank guarantees bills of exchange issued by importers.  

An easier way to understand Cuban trade finance assets is through an example. Lets say that a European food distributor sells flour to the corporation in charge of managing hotels in Cuba. The flour is usually sold at a premium price due to the US embargo. The Cuban corporation would then make arrangements to repay the debt in, say, six months. The European food distributor will immediately turn around and sell its promissory note (or letter of credit) to a local bank at a discount. Investors buy the paper from the local bank and receive the payment six months down the road from the Cuban corporation.  

A few Canadian and Trinidadian banks offer this type of investment to their wealthy clients. Each trade finance asset is unique and presents a different risk level depending of the financial stability of the underlying Cuban corporation (obligor) and the term of the paper. Today’s trade finance assets generally yield between 8 per cent and 20 per cent, higher rates usually representing a greater risk of late payment. Note that the exceptional high interest paid is the result of the US embargo and not representative of the risk presented by the investments. The related scarcity of capital makes trade finance assets a potentially extremely lucrative proposition. 

As an asset manager, I have been involved with Cuban trade finance assets for many years, I have experienced the best and the worst. Particularly fresh in my memory is the month of March 2009 when the Cuban government stopped all remittance of foreign assets outside of Cuba, de facto locking my clients’ capital in the country. The situation lasted for a few months but patient clients received all of their capital and interest plus a bonus interest for the wait, which was a far better return than what most other investments provided for the period.  


A bright future 

Recent macroeconomic policies implemented by the Cuban Government have been characterised as prudent, practical and successful in steering the country towards stability and recovery. Since 2005 Cuba has transformed its balance of payments accounts by successfully developing the sale of medical services to Venezuela, Panama and other countries. Cuba’s current fiscal and monetary policies are set to ensure the country’s future solvency and liquidity. The alliance with Venezuela has permitted Cuba to invest in a range of needed social and production programmes, without detriment to the country’s ability to pay. Cuba is substantially under-borrowed by almost any global standard, and certainly by comparison to other countries in the region. As the economy emerges investors should look to it as an excellent source of diversification. 


Disclaimer: I have recently become part of the investment management team for a newly launched Cayman Islands registered mutual fund, Sierra Maestra Limited. This fund seeks to provide investors with an attractive rate of return from a diversified portfolio of Cuban trade finance assets. I have therefore an interest in the situation in Cuba and the returns provided to investors from Cuban trade finance assets.