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Cuba: Government is opening up the economy amidst the worst economic crisis in more than three decades

19/02/2021

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Event

In the past months, Cuba has announced a series of market-oriented reforms. Firstly, private participation will be permitted for more than 2,000 professions, while only 124 areas will be administered partly or wholly for the state. This is a huge increase compared to the 127 professions that were allowed to have an element of private participation to them. That being said, the Cuban government will retain control over strategic sectors such as energy. Secondly, the two-currency system that has been in place since 1994 is being phased out as of 1 January 2021. Indeed, after more than a decade of debate and preparations, the convertible peso (CUC) is disappearing, leaving the Cuban peso as the only currency. Furthermore, the Cuban peso was devaluated from a parity with the US dollar to 24 pesos to the USD. This large devaluation is likely to continue as the exchange rate is still overvalued. Another important reform as part of the adoption of free-market practices is the plan to end subsidies to some state companies.

Impact

These market-oriented reforms come at a time when Cuba is struggling with its worst economic crisis since the fall of the Soviet Union, more than 3 decades ago. Cuba’s fragile economy was already reeling from a tightening of economic sanctions introduced by the Trump administration since 2017 and the lower aid of Venezuela, whose economy is in a severe crisis. The Covid-19 pandemic proved to be a serious blow to the economy. Indeed, after years with a rather sluggish economic performance, the Cuban economy is expected to have contracted by a staggering 11% in 2020, according to the government. Indeed, Cuba is expected to be one of the most affected countries in Latin America while the region experienced the worst recession in the world last year (according to the IMF February update, the Latin American average real GDP growth is estimated at -7.4% for 2020). Furthermore, the pandemic has cut off Cuba from tourism revenue – a main source of current account receipts – leaving it short of hard currencies. On top of that, as the island is very dependent on imports, it struggles with shortages of basic goods.

The announced market-oriented reforms are meant to alleviate the economic pain. That being said, in the short term there will still be numerous economic challenges while the system is adjusted. For example, the two-currency system has proven to be very distortive and an obstacle to the local production of food. However, the devaluation – the first one since the 1959 revolution – has led to a rise in inflation despite tighter price controls. Furthermore, these tighter price controls increase the risk of shortages of goods and supply chain disruptions. In the short term, another painful impact of the devaluation in combination with cuts in subsidies is a likely rise in bankruptcies and large-scale layoffs of employees in state companies. Finally, these reforms might also lead to popular discontent in the short term due to rising inflation, possible higher unemployment and shortages of goods.
 
Nevertheless, in the medium term, these reforms will support the economy, due to greater productivity and efficiency, for example. Moreover, these market-oriented reforms will probably give an extra incentive to restore some elements of the 2014-17 rapprochement with the US that took place under president Obama. Indeed, a warming of the relations with the US will be important for Cuba to lift its economy out of the economic crisis. That being said, the adoption of stronger market-oriented measures is unlikely to be linear and will probably consist of back-and-forth moves.

Both for ST and MLT political risk, Cuba is classified in the highest risk category 7/7. The outlook remains stable, owing to Cuba’s history of default on external debt, a poor payment record and the lack of reliable data.

Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com

19/02/2021

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