Cuba: The next big frontier market or a trap for unwary investors?

Potential – this is a much overused word in frontier market investing, but it neatly sums up Cuba’s business prospects. Thanks to recent detente with the USA the island has come off the US State Department’s list of terrorist sponsoring nations and US citizens are now travelling to the country more freely, plus there is also talk of full trade relations being restored soon. Many of these new visitors are Cuban-Americans with ambitious business plans for the country with many focusing on the real estate, tourism and entertainment sectors. At the same time the Cuban government has been making small steps to liberalise the economy and allow private enterprise.

Observers are now confidently predicting the rise of the free market in Cuba and the rapid spread of US firms across the island, indeed a common tourist pitch is to see the island before the end of communism, but will Cuba really make the transition from socialism to capitalism and if it does will it be a smooth process that results in suitable opportunities for outside investors?

A new dawn in US- Cuba relations

Relations between the two nations have improved thanks to President Obama’s new open minded approach to Cuba, but also because the Caribbean island has lost its patrons. The Soviet Union collapsed at the end of Cold War leaving Cuba in severe economic dire straits. More recently Venezuela stepped into the breach supporting the island with cheap oil, but has now run into financial difficulties of its own thanks to a tanking oil price and a high spending bill. Despite this help Cuba continued to suffer from poor economic performance thanks to its socialist policies, but also because of a trade embargo with what should be its biggest trade partner – the United States. China was the only country that could have realistically stepped in and kept the island afloat financially, but Beijing was never likely to risk annoying Washington over a small country like Cuba.

Reality Check

While ties have been established and embassies reopened, relations have not been fully restored with the US and Cuba is a long way off from being the free market paradise many would wish it to be. Foreigners can only invest in a few sectors of the economy and the government are not likely to relinquish control over major sectors of the economy in a hurry and many Cubans may resent outsiders muscling in to buy  businesses and land on the island.

Where there has been foreign investment it has not always been a success – the Mariel free port financed by Brazilians and managed by a Singaporean entity has disappointed so far. The Cuban government (probably correctly) fear that if they give up too much power and let the American companies in they will be removed from power and the country will become a vassal of Washington. That said the free market is making progress in the island as small businesses spring up and ideas of entrepreneurialism spread.

In theory the island looks like a prime opportunity for frontier investors with the prospect of the US lifting its trade embargo and a populace eager for change and decent goods and services. But the Helm-Burton Act still requires repealing before full business relations can be restored, until this happens any US firms will continue to find doing business difficult. But it is the Cuban’s government’s actions which will have the most weight, will they continue to open up the economy or halt the recent reforms in a bid to retain socialism on the island. Further liberalisation should open the door for outsiders to invest more freely in real estate, telecommunications, construction and tourism – all sectors Cuba has clear advantages in or demand for.

Cuba’s surprising advantage

Despite its lack of economic opportunities Cuba has an impressive record in medical care and educational achievements which has given the country a big unrealised advantage in terms of a highly skilled workforce – the country has a surfeit of doctors, scientists and other high skilled individuals who thanks to the structure of the economy have to make a living as taxi drivers, hairdressers etc. The country could and should have a major advantage in the so called knowledge sector – research, computing, healthcare, and pharma. Naturally it helps that Cubans speak Spanish a major world language and further liberalisation could see a lot of these highly skilled people start businesses or work for foreign investors that match their skillset. The danger is of course that they emigrate and put their skills to work in other countries. Cuba cannot develop this sector until it allows more freedom in terms of internet access, which currently is severely restricted. For example some firms like AirBnB are active in Cuba but have to use SMS to run their operations effectively.

Golden opportunities?

Despite the downsides Cuba remains an interesting long term market and those investing early on could gain a major first mover advantage, the country has 11 million people, not an insignificant number, the presence of many Cuban-Americans may act as a stimulant to the economy, but also as tough competitors to other outsiders. As we have seen there are considerable downsides to investing in the country, political uncertainty being the foremost of these, but if Cuba continues to open its economy there is no doubt there are golden business opportunities to be found there.

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