Dealing with the New Cuba

CUBA painted on wall

Every December, many faithful Cubans travel from across the country to El Rincón, about 25 kilometres south of Havana, where they visit the Sanctuary of Saint Lazarus, a revered Christian saint reportedly brought back from the dead (as well as the Afro-Cuban Yoruba healer god Babalú Aye). During the most recent pilgrimage, citizens of all religious stripes had a man-made miracle to celebrate. On Dec. 17, 2014, the Cuban economy was in some ways raised from the dead by Cuban President Raúl Castro and U.S. President Barack Obama. The two leaders jointly announced a historic agreement to begin normalizing relations between their nations. Putting an end to decades of unproductive hostility, the Obama administration will move to fully restore diplomatic ties with Cuba and ease travel and commerce restrictions. The White House has also pledged to push the U.S. Congress to end the American trade embargo that has attempted to cripple the island nation’s economy for decades and nearly managed to do so in the 1990s before Venezuela emerged as Cuba’s new lifeline.

The embargo is actually a complex set of economic sanctions that must pass through different political processes in order to be amended. President Obama has taken action to review, amend and lift as many as he can under his own authority. However, the Helms–Burton Act of 1996 codified the main provisions of the embargo into law and thus took the right to lift them away from the president. Since only a vote by Congress can revoke the Act, lifting all sanctions against Cuba will prove difficult. The most likely scenario in the short to medium term would see parts of the embargo being removed a bit at a time, creating a “Swiss cheese” policy with gaping holes. The largest holes would be created by the end of the travel ban on U.S. tourists and by the removal of Cuba from the list of states that sponsor terrorism. The former, in particular, would be bound to generate powerful incentives for the easing of other embargo restrictions as U.S. hotel chains, travel firms and catering companies would want to enter the Cuban market to reap economic benefits from the inflow of American tourists, and U.S. engineering and construction firms would want to participate in the needed upgrade of Cuba’s tourism facilities and related infrastructure. The latter would facilitate all manner of international financial transactions, as banks and other institutions in the United States and elsewhere would no longer face fines for doing business with Cuba.

Following the December 17 announcement, Canadian companies already on the island and those considering entering this market immediately started to ponder the potential opportunities and risks that normalized relations between Cuba and the United States represent. Royal Bank of Canada chief executive David McKay, for example, told The Globe and Mail that the deal, which was brokered by Pope Francis, had Canada’s second-largest lender by assets thinking about returning to Cuba, which RBC abandoned in the 1960s after doing business in the Caribbean nation since 1899. “We see a very attractive, long-term marketplace in Cuba,” McKay said, noting the bank’s management team had been anticipating a shift in Cuba’s potential as a foreign market “for quite some time.”

Speculation that a move toward normalization of relations between Cuba and the United States might be imminent has been a recurring theme for decades. In 2006, speculation was spurred once again by the announcement that Fidel Castro had fallen gravely ill and would be replaced by his brother Raúl. Naturally, there was a wave of interest in the potential opportunities and threats that would be presented by a post-embargo Cuba. We wrote several articles on the subject. In “Oh, Canada, Will Cuba Stand on Guard for Thee? Preparing for the End of the U.S. Embargo on Cuba,” which appeared in this publication in 2009, we described the nature of the trade and investment restrictions and how their gradual dismantling could affect Canadian business interests already on the island and possibly those on their way there. We also offered a series of recommendations meant to assist competitive assessments.

While the actual move toward normalization has taken eight years longer than expected, President Raúl Castro has been busy reforming Cuba’s moribund economy more along market lines. This paper examines whether or not the current anticipation of new business opportunities is warranted while taking a fresh look at the investment and trade potential and risks that a more market-friendly, post-embargo Cuba presents to foreign investors and traders.

CANADA’S RELATIONSHIP WITH CUBA

Canada–Cuba business relations have ebbed and flowed as much as Canadian rivers during spring thaw. The business rapprochement between the two nations began in the early 1990s after the collapse of the Soviet bloc, an era that the Cubans euphemistically call “the special period in time of peace.” With the loss of its Soviet benefactor and a looming economic crisis, the Cuban government needed to urgently find alternative finances, technology and markets, so Havana moved to actively seek formerly shunned foreign investment and commercial trade partners. Cuba updated its trade and investment regulations (Law 77 of 1995), opened new financial facilities, and sent managers abroad to learn management techniques. At the same time, the Caribbean island won the hearts and minds of an ever-increasing number of international tourists. As a result, the mid-1990s were relatively heady days for Canada–Cuba business relations, as Canadian traders and investors happily filled the gap left by the disappearance of COMECON, the Soviet-led economic association of communist countries established in 1949 to facilitate trade and development. However, American sanctions such as the Helms–Burton Law of 1996 and the post-9/11 Patriot Act somewhat restrained the enthusiasm of Cuba’s Canadian business partners. And a big chill in Canada–Cuba commerce emerged in the late 1990s, when medium- and smaller- sized joint ventures experienced a policy-led culling that betrayed Cuba’s preference for Soviet-style state-led industrial gigantism. Many traders experienced a culling of their own as the balance of unpaid commercial accounts exploded and Canadian government-backed credit windows were maxed out. In October 2000, the United States made matters worse by renewing sales of agricultural products to Cuba, thus eliminating market opportunities for Canadians taking advantage of embargo-created market distortions.

The darkest moments for many foreign business interests in Cuba came in 2011. Doing business in the nation, as indicated by the popular Cuban refrain no es fácil, is not easy. When people call it “interesting,” they often really mean frustrating or infuriating. After all, when compared to other countries, Cuba has a “disabling” rather than “enabling” business environment (e.g. red tape, overbearing top-down bureaucracy, fickle deals, changing priorities, credit shortages, etc.). But Raúl Castro’s 2011 campaign to rein in business corruption created a significant new challenge. Indeed, what is considered acceptable in Cuba changed with the new leadership, but the new rules of the game were not made immediately clear. And as many local and foreign business people have learned the hard way, fairness isn’t always a priority because no one can fight City Hall, at least not when it flies the Cuban flag. Canadian businessman Cy Tokmakjian, the 70-plus-year-old founder of the Tokmakjian Group transportation firm, one of the largest foreign operations in the country, was arrested by Cuban authorities in September 2011 and held until recently without charges in Cuba’s La Condesa prison. Sarkis Yacoubian, another Canadian, was sentenced to nine years in jail in a less-than-transparent corruption trial in June 2013 and, a few months later, was abruptly expelled from Cuba with no official explanation from Havana’s government.

Despite all of the above, Canada’s relationship with Cuba remain significant. With over 1.1 million Canadians traveling to the island each year, Canada is Cuba’s largest source of tourists by a wide margin. In 2013, Canada was Cuba’s fifth-largest merchandise trading partner, benefiting from about $900 million in bilateral trade, behind Venezuela, China, Spain and the Netherlands Antilles. Supported by The Canadian Commercial Corporation (CCC), Canadian exports to Cuba currently consist of agricultural products (especially wheat) and industrial equipment for mining, electricity generation, transportation, telecommunications and papermaking. Canadian imports from Cuba are dominated by nickel, but also include rum, cigars, frozen lobsters and coffee.

There are a number of bright lights on the investment side. Canadian firms have substantial investments in Cuba’s mining, electricity, oil, agri-food and tourism sectors. Sherritt International has been a steadfast player in mining, power and oil despite the ups and downs of the international nickel price, and various traders in commodities have done well. The patience, fortitude and steadiness of 360 Vox Corporation (formerly Leisure Canada) in the tourism and real estate sectors will most certainly be handsomely rewarded soon.

CUBA MARKET RISING

Barring some unexpected events (such as the Mariel boatlift and the Elián tug of war) or geopolitical crises (like the shooting of the Miami-based Brothers to the Rescue planes by Cuban jets that resulted in the enactment of the Helms–Burton Law), the end of the U.S. embargo certainly appears nigh. When the day comes that anyone can use an American credit card in Havana, there is really no turning back, especially after the codified travel ban is completely lifted. What remains to be seen is how the Cubans can manage to improve their business environment while achieving their primary objective of preserving the country’s socialist values and its state-centered economy.

One indication that Cuba is serious about allowing an increased market presence in the country is the new Foreign Investment Law (No. 118) enacted in March 2014. Another positive sign is the new special development zone created around a new container hub at the port of Mariel. The Cuban government has put together a portfolio of investment opportunities consisting of 246 projects with an estimated value of US$8.7 billion. Collectively, they are expected to generate as much as US$2.5 billion in annual investment, which Cuba estimates is required to stimulate economic development. The sectors involved include food, biotech/pharmaceuticals, basic industry, transportation infrastructure, waste management, environmental remediation, tourism, mining, oil and gas.

The new foreign investment law and the kinds of projects contained in the portfolio mentioned above are in line with the Economic and Social Policy Guidelines of the Party and the Revolution (a.k.a. Lineamientos), which is the closest thing Cuba has to a development plan. While rooted in a socialist socio-economic model of development, the policy mix in question allows, once again in principle like in Law 77 but perhaps this time in practice, for 100 per cent foreign-owned ventures. And although citizens residing on the island are excluded, investment by Americans and Cuban nationals residing abroad is allowed.

The focus on large investment projects, especially in the special development zone around Mariel, could prove detrimental to small- and medium-sized enterprises (SMEs) and other geographic regions. That said, related clusters, spin-offs and supply/value chain linkages could eventually provide benefits for these smaller enterprises and the less advantaged regions of the country.

Of special interest to Canadians are projects involving exploration and environmental remediation in the extractive industries, transportation infrastructure development, and waste management. Since several projects are in the food growing and processing sector for both internal consumption (especially import substitution) and export, Canadian agricultural inputs (e.g. potassium chloride for fertilizers, machinery and parts) also have good potential.

That said, change never treats everyone the same. And as Cuba begins to overcome its chronic economic woes, there is no question that future business prospects look very bright for some and rather dark for others. In general, it appears as if it is indeed time for Americans and Cubans to sing “happy times are here again.” For everyone else, a significant amount of uncertainty remains. As a result, Canadian traders and investors should review opportunities carefully and determine if they can be competitive in the short run while the U.S. embargo is not fully lifted, and in the long term when Cuba becomes just another “normal” trade and investment destination.

STRATEGIES FOR A NORMALIZED CUBA

We think Cuba is really finally ready to “open for business” via the normalization of relations with the United States, which will unleash a dynamic that will move Cuba toward a more market-driven socialism.

Circumstances, of course, have changed since we first looked at the opportunities presented by a post-embargo Cuba. Among other things, no oil has been discovered in Cuba’s deep waters in the Gulf of Mexico; Venezuela is spiraling into a deep economic crisis through poor economic management and lower oil prices; and the SME sector has been opened. Nevertheless, the basic strategic analysis framework we previously developed for a post-embargo Cuba is still as relevant as it was at the time of writing.

Simply put, existing business partners must be prepared to modify or change their strategies to fit with an open and more competitive Cuban market. They must plan to compete with other international interests, ranging from the Europeans and the Chinese to South American interests and Cuban-Americans, not to mention the hungry U.S. businesses that desire a big bite of the long-forbidden fruit. As we noted in our previous IBJ article, the impact of U.S. businesses, including Cuban-American concerns, on the Cuban business landscape will be enormous. And some Canadian companies will find that they cannot compete effectively with Cuba’s natural U.S. trading partners (or that compensation for the owners of the nationalized assets they have been using becomes too onerous or cumbersome).

In essence, there are two different timeframes to plan for: 1) between now and the lifting of all U.S. restrictions; and 2) once Cuba becomes just another “normal” country to invest in and trade with, albeit a socialist one.

Moving forward, Canadian business enterprises need to be aware that their experience on the island does confer a first-mover advantage. Sherritt International’s stock jumped when the plan to normalize U.S.–Cuba relations was announced. But past business camaraderie will not be enough to prosper in the new Cuba if the basic value proposition is not competitive.

A proxy of competitiveness in a post-embargo Cuba can be developed by benchmarking a company’s value proposition against those of companies that are already successful in a specific sector or commodity in “similar” Caribbean Basin countries. If direct exports to the island don’t make sense, supply-chain strategies involving American consolidators, wholesalers or final good assemblers are also possible.

The “big bang” for Canadian professional service providers such as engineering firms and commercial banks, especially those with a track record on the island, will only occur after Cuba becomes an approved recipient of international financial institution loans and investments.

The bottom line is that Cuba is a quirky country that can be financially and legally treacherous for international business ventures. And even if the long-awaited market opening happens as announced, it will be done “a la Cubana,” which means existing and potential Canadian business partners must have patience and nerves of steel — in addition to capital.

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