CUBA: Preparing For Perestroika

[El Presidente]

http://www.businessinsider.com/cuba-prepar...estroika-2011-3

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 '20s, when the island led the world in sugar exports and the future seemed sky blue.

President Gerardo Machado dreamed of turning Cuba into the Switzerland of the Americas. He decided that his 4 million countrymen needed a domed capitol building even taller and more ornate than the one he toured in Washington. So Cuba's Congress dutifully poured 3% of the country's GDP into their new home. (This would be akin to the US Congress spending $420 billion for a new office today, but let's not give them any ideas…)

It took 8,000 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. Work completed in 1929, just as America's stock market crashed and the Great Depression unfolded.

The Smoot-Hawley tariffs crushed Cuban sugar prices by 74%. When El Capitolio's ribbon was cut in 1931, Cuba's economy lay in tatters. Machado was forced out of office, and his dream building would perform congressional service for only 28 years before Fidel Castro's revolutionaries swept into Havana and opted for more austere premises. I don't need to recite the history from here, which you probably well know.

The winds of change are gathering in Cuba, though. Since Fidel Castro's health nearly failed in 2006, power has passed to his younger brother, Raul Castro. Raul has quietly reshuffled more than 30 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 anymore."

The global economic crisis whacked Cuba hard. 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.

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 hold an estimated 5-20 billion barrels of oil and 20 trillion cubic feet of natural gas. (Note: This compares with 29 billion barrels 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.

Raul Castro has issued a far-reaching five-year road map for Cuba's future economic reform. 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, merge the two-tier currency system, close down inefficient state enterprises, decentralize state ownership, facilitate private ownership of businesses, distribute idle 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 500,000 state workers (that's 10% of the country's government work force in a country where 85% of workers work for the state) 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. A million Cuban-Americans call Miami home. Cuba has 60% of 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 is plentiful. Cuba's once-vaunted sugar industry stands in disarray, with 80% of the old mills shut down. However, 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.

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. 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 five-seven years are available.

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.

Regards,

Douglas Clayton

for The Daily Reckoning

[asudevil08]

I know its been talked about on here and other forums before, but it'd be interesting to see what would become of our beloved Tobacco. I can imagine investment and QA would only make everything that comes out of there better. (within reason) Opposite side of the coin exists as well though. Conundrum Cuba, conundrum.

[mazolaman]

In many ways,Cuba gets viewed as a Guinea pig,we're all interested to see what will happen as things change there.

My gut feeling is that it could get messy,a bit of a grab grab grab scenario,but....who knows?

As Sir Winston said of Russia...a riddle wrapped in a mystery,inside an enigma....seems to fit for Cuba

In the past,re cigars,when demand has increased,quality has dropped....so now that demand is down,quality is up...so,a lot depends on how the US market reacts after the borders are down,and if under a different system,production can be increased without a drop in quality.....

[DarkSky]

Don't forget - if the US lifts the embargo, prices in Cuba will SKYROCKET for tourists. With an open door to a new market of 300+ million just 90 miles away, cigar prices will go through the roof. Not to mention weekly resort packages and hotel room rates in Cuba will go up with all the new demand.

I'm heading there in 5 days and am rather liking my $55/night all inclusive resort rate and $107 for a 25 box of Monte 4's. Selfish statement I suppose. But once the U.S. is open to the Cuba market of cigars and tourism, I'll be able to afford neither.

[sloth]

Is it just me or is the non-US tourists just low-ballin' Cuba? If you guys were charged the USA rate there would be no economical issues in Cuba. [/tongue firmly planted in cheek]

[CanuckSARTech]

Is it just me or is the non-US tourists just low-ballin' Cuba? If you guys were charged the USA rate there would be no economical issues in Cuba. [/tongue firmly planted in cheek]

No different from what the U.S. has going on with Mexico, and the resorts there.

I think that Cuba travel-operators try to make it cheaper and more appealing to attract potential customers worldwide, DUE TO the U.S. embargo, I think anyways. Cheaper costs to try to make up the offset of dealing with the "stigma" that many perceive with it being a communist country, as well as the sometimes hassles due to credit card/financial issues and the block on tie-ins to the U.S. financial system.

Just a thought, anyways.

[Dbone]

We can only hope it betters the lives of those who call Cuba home.

[headstand]

Don't forget - if the US lifts the embargo, prices in Cuba will SKYROCKET for tourists. With an open door to a new market of 300+ million just 90 miles away, cigar prices will go through the roof. Not to mention weekly resort packages and hotel room rates in Cuba will go up with all the new demand.

I'm heading there in 5 days and am rather liking my $55/night all inclusive resort rate and $107 for a 25 box of Monte 4's. Selfish statement I suppose. But once the U.S. is open to the Cuba market of cigars and tourism, I'll be able to afford neither.

Just the excuse I needed to stock up on boxes of cigars - beat the rush

[sloth]

No different from what the U.S. has going on with Mexico, and the resorts there.

I think that Cuba travel-operators try to make it cheaper and more appealing to attract potential customers worldwide, DUE TO the U.S. embargo, I think anyways. Cheaper costs to try to make up the offset of dealing with the "stigma" that many perceive with it being a communist country, as well as the sometimes hassles due to credit card/financial issues and the block on tie-ins to the U.S. financial system.

Just a thought, anyways.

I was joking, but it is not like what the US has going with Mexico. Unless you are going to tell me Canadians smuggle guns into Cuba for cigars...

[CanuckSARTech]

I was joking, but it is not like what the US has going with Mexico. Unless you are going to tell me Canadians smuggle guns into Cuba for cigars...

Yeah, I got that you were joking. And no, we don't smuggle guns in - we used to bring DVDs and CDs and the like in, but since those are allowed and common, we now bring in those other contraband items: simple things, like soap, beauty products, candy, etc.

And, what I was trying to get at is yes, Cuba is a cheap place for us to vacation. And any Canadian going there generally understands it - a 4- or 5-star in Cuba is generally comparable to only a 3-star at best in most of the rest of the Carribean. But, it's not that the non-U.S. visitors are low balling, and not paying the "U.S. rate". It's that the U.S. visitors get charged the extra "inconvenience fees" for the additional inconvenience that you have to go through with the Embargo being in place, and the extra inconvenience that the Cuba has to deal with also. Of course they're going to make you pay extra - a large part (aside from the obvious Castro brothers) of why the situation is what it is, is due to U.S. policies.

You guys get some decent rates in Mexico, 'cause its favourable for them to cater to Americans. I have some friends who went to a resort in Mexico, recommended by my wife's U.S. cousins. The Canadian friends had to pay more, as our carriers here apparently couldn't offer the same discounted rate plans as was being offered to American customers.

So, you have drug-ridden and murder-and-decapitation-happy Mexico, and we have dilapidated and propaganda-filled Cuba. Flip of the coin, either way. Winning decision goes to the country with the best cigars, though!

[frenchkiwi]

"Cuba could transform into one of the world's most attractive frontier investment destinations."

yes i can hear the foreign magnates licking their lips. let's buy up this little island and sell access to our own legions. maybe we could even get the locals to be dependent on buying our $hit.

"America has a long track record of turning bitter rivals into productive partners (a recent example being Vietnam)"

I don't know whether to laugh or cry at this. I think crying is more appropriate considering the amount of suffering involved in all the developing countries that have been "turned" into "productive partners" by large powers.

if this all happened with substantial local control and ownership stakes a good balance could be struck for cuban development. but how many places in the world have we seen that happen???

[sloth]

and we have dilapidated and propaganda-filled Cuba.

Ah, don't forget Nicaragua!

Winning decision goes to the country with the best cigars, though!

touché

[Orion21]

They will skyrocket short-term due to a demand shock but will eventually even out to compete with relatively cheap prices in DR, PR, CR, etc. Right now, their pricing is out of touch with the rest of the world because they are subsidized/government owned and can afford to offer services at lower prices than competing nations. If, as this article predicts, the market becomes open and many industries lose government subsidies, prices will eventually move towards equilibrium.

It will take years if not decades to build the facilities needed to create that type of demand. The fact is Mr. & Mrs. USA are not going to drop their plans to go to Disney World to take a trip to Cuba -- a country they have heard is run down and third world. The people that will flock to Cuba are the immigrants that haven't been home in decades, cigar aficionados, and thrill seekers that like adventure. This will increase prices, but not to the extent you are implying. I would be very surprised if we see cigar prices rise that much. Point in fact, pricing for Cubans haven't risen in years even when demand was high. Habanos just increased production.

[DarkSky]

It comes down to simple supply and demand. If there's a resort with 500 rooms and after the embargo is lifted and the 300+ million US citizens can travel there, and there's demand for 800 rooms but only 500 available, prices will increase to get top dollar for those 500. Same as cigars. If a factory has 1000 boxes, prices are set to sell those 1000 boxes for as much as they can get. But if all the cigar lovers in the US also want those 1000 boxes, prices will rise. With a new influx of US tourists going, prices for everything will only increase.

Great for Cuba and it's people though. But it'll mean that $150 box of cigars soon becomes $200, 250, 300, etc.. simply because there'll be new customers willing to pay it.

And/or, as someone previously said... they'll really ramp up production to keep supply available at the same price, and quality will drop.

But if you had every cigar store across the US starting to stock Cuban cigars, and there's only so many cigars to be had... prices will go up.

[cigcars]

*One of the forum members spoke of what would be the effects on our beloved tobacco among other things due to planting changes, other building growth, etc. Cuba knows its tobacco product is coveted all over the world and that they would lose sizeable income if that were affected. Even when Fidel took power in 1959 and forced all those sugar cane fields AND tobacco farms to be used to grow actual food for his hungry people, he found later in the 1970's thru 1990's that Cuba's cigar tobacco being marketed brought additional hundreds of millions of dollars into its economy. Cuba arguable has the best sugar, the best rum, and the best tobacco on earth. I'm sure that when (or if) the Embargo ends there will be at least a temporary boom to their locales selling fake havanas, as well as "floor sweepings" cigars to many an unsuspecting American citizen, among other things and items.

When all that subsides there will be educating and spreading of knowledge to persons visiting the Island so they can know how to recognize what they're looking for. Then there would be inquiries and interests by some of us out here for possible investments in Cuban items (if that were possible for us Joe and Jane Averages) such as coffee, sugar, medical training and doctors' services abroad, and of course - cigars! There'd be, I'm sure, endless possibilites.