Evaluating the Climate for Foreign Investment in Cuba

Cuba announced in May the next step in its economic transition by allowing legal status for private businesses.

Previously, the communist government permitted individuals to operate as self-employed workers under several hundred clearly-defined roles such as taxi driver. The latest announcement will likely take months to become law.

“Private property in certain means of production contributes to employment, economic efficiency and well-being, in a context in which socialist property relationships predominate,” reads one section of the “Conceptualization of the Cuban Economic and Social Model of Socialist Development.”

Once considered to be a mortal threat to the Cuba regime, private businesses – and business people in particular – will now have official status and will hopefully find an end to the practice of radom crackdowns and suspicion that threatens to undermine emerging capitalists seeking to satisfy demand for goods and services.

Price distortions tend to undermine capital formation and private sector employment. As the Cuban government gropes for private sector alternatives to government employment in inefficient state enterprises, it is no surprise that the emerging private restaurants (paladares), taxi drivers and small shops would be officially integrated into the economy. The promise it that these small businesses successfully negotiate price distortions and offer stability amid the wrenching transition away from a centrally planned economy.

It appears the new law granting private companies formal status in the economy will not change the practice of requiring foreign investors to partner with Cuban government entities.

Investment Climate for Foreign Investors in Cuba

Cuba has a number of non-tariff measures, institutional and infrastructural factors, and other barriers that affect the ability of foreign partners to trade with or invest in the country.

Some of these factors are possible barriers because they are not yet faced by US firms, due to the limited involvement of US firms in the Cuban market; some are possible barriers because they do not necessarily act as barriers to all firms; and others are perceived as barriers, although it is not clear to what extent they might act as such.

Cuba’s monopoly over almost all aspects of the economy – and the fact that reforms to open the market are both recent and relatively slow-moving – add to uncertainty for those planning to do business in the island nation.

Cuba depends heavily on imports, and many of its trade processes—such as customs duties and procedures, and the sanitary and phytosanitary measures applied to agricultural imports—do not appear to hinder trade. In fact, it is Cuba’s lack of hard foreign currency and domestic fiscal constraints that limits its ability to import. This situation has led to an increase in market share for countries that are willing and able to provide Cuba with generous credit terms – in some cases extending into multiple years. As a result, the Cuban market may not be as open to US goods as it would otherwise be.

The Cuban government has recently loosened some restrictions on foreign investment, and it has been actively seeking investment in areas it believes will eventually allow Cuba to substitute its own products for foreign imports, such as agricultural products and light manufacturing. These changes are too recent to accurately assess their impact.

Cuba’s central planners have indicated that it will need $2-2.5 billion in foreign investment annually to meet targeted growth rates and reduce its dependence on imports. With the dissolution of the USSR in the 1990s and, more recently, Venezuela, it is vital that Cuba deliver both economic growth and economic development towards a economy driven by the private sector. As such, potential foreign investors and trading partners should anticipate further loosening of rules design to attract interest in Cuba.

Here are the key factors to consider when contemplating doing business in Cuba:

• Politics in Cuban trade and investment decisions. That the Cuban government frequently makes decisions about trade and investment based on political factors rather than on economic rationale was widely cited as the single most important factor affecting the ability of US and foreign companies to do business in Cuba. Political considerations include, among others, an interest in furthering the country’s foreign policy agenda; the desire to advance the country’s domestic social policies and programs; a preference for diversifying Cuba’s trading partners to protect the country from external shocks; and patterns of historical relationships, as well as the trust, or lack thereof, resulting from them.

• Cuba’s investment climate. Cuba’s 2014 foreign investment law provides for foreign direct investment (FDI) through joint ventures, wholly foreign-owned entities, or contract investments (such as contracts for hotel management or the provision of professional services). In practice, however, Cuba’s government remains unwilling to approve most FDI projects that include wholly foreign-owned entities. Most approved projects are joint ventures (with at least a 51% Cuban equity share) or contract investments. In addition, a package of tax incentives for foreign investors is available only to joint venture projects. Joint venture projects listed in the government’s Portfolio of Opportunities for Foreign Investment are quickly approved, as are projects that are in the Mariel Special Economic Development Zone or that meet other Cuban government objectives.

Click here to read about Uniliver’s recent deal to retain controlling interest in its partnership with the Cuban government.

• Physical property rights and other barriers to investment. The lack of rights to own land and some physical goods in Cuba is a significant concern for foreign investors in Cuba. Although long-term leases are available in some cases, most land in Cuba is owned by the state. Restrictions on foreign ownership of real property create obvious risks for foreign companies seeking to conduct business in Cuba. This, combined with numerous other investor concerns—including competing or partnering with state-owned enterprises; the country’s labor system, which can complicate both hiring and laying off workers; onerous approval processes; and licensing procedures—creates an atmosphere that is generally considered challenging to foreign investment in Cuba.

• Cuban legal system, dispute settlement, and anti-corruption efforts. The Cuban legal system has been a cause for concern, particularly for potential foreign investors in Cuba. Cuban lawyers are all employees of the Cuban government; there is no private practice of law in Cuba. The domestic arbitration system lacks transparency, so there is little information available to determine whether the system is fair to foreign investors or favors the state. While some industry sources say it is difficult or impossible to find favorable resolutions of disputes against the Cuban government, others suggest that in commercial matters, the system is fair and often finds against the government. In matters relating to national security, however, or those with political implications, it is generally agreed that the Cuban government will prevail. The Cuban government’s recent willingness to allow international arbitration clauses in contracts may indicate a desire to create a friendlier environment for foreign investment.

• Intellectual property (IP) rights. Many of Cuba’s IP laws and institutions have evolved to address the requirements of the World Trade Organization’s (WTO) Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). In the area of trademarks and patents, for example, Cuba has modern laws and functioning administrative systems. By contrast, Cuba’s copyright law has not been modified to comply with TRIPS or to address the digital environment. Copyright infringement reportedly is widespread and pervasive. Notwithstanding the wide gaps in legal protections, US and other foreign IP owners are registering their rights in Cuba and exploring market access and collaboration opportunities. While modernization of the Cuban copyright regime to address these problems could provide opportunities for US and Cuban creators of copyright-sensitive products, the removal of US restrictions would not be expected to have a large impact on US firms in the near term, given the need for legal reforms and current economic conditions in Cuba.

• Dual currency and exchange rates. Cuba currently uses two currencies, the Cuban peso (CUP) and the convertible peso (CUC), neither convertible outside of Cuba. Pegged to the US dollar, the CUC is used for foreign trade, the tourism sector, some restaurants and paladares (private restaurants), high-end stores, and much of the private sector. The CUP is used by the Cuban population for most domestic transactions, and all wages to Cubans are paid in CUP, regardless of the sector in which they work. Cuba also has multiple exchange rates. An official exchange rate of 1 CUP: 1 CUC is used by the government and all state-owned entities, while exchange centers use a rate of 24 CUP: 1 CUC or 25 CUP: 1 CUC, depending on whether the currency is being bought or sold. The multiple currencies and exchange rates have created serious distortions in the Cuban economy. The government announced plans to merge the two currencies by April 2016, but the merger appears to be delayed, and official information on the process has yet to be released. For foreign investors, Cuba’s dual currency and exchange rates add a layer of confusion to an already complex business environment. Unification will ultimately ease business operations, but the uncertainties associated with the process concern investors.

• State trading, storage, and distribution. The Cuban government currently controls most aspects of international trade and domestic distribution. Most imports and exports go through Cuban state-owned entities, and distribution is controlled by the government. To encourage foreign investment, the government has allowed some foreign firms to import and export directly, but the growing private sector and cooperatives in Cuba have little to no ability to source or access the foreign inputs they need if they are to grow. Further, an inefficient distribution process causes supply bottlenecks throughout the country. One result of these limitations is that an increasing flow of the goods needed for the private and cooperative sectors, valued as high as $3.5 billion yearly, is entering Cuba via travelers from the US. If US restrictions are removed, growth in US exports to Cuba likely will continue to depend on the purchasing decisions of Cuban importing entities. The degree of government control over storage and distribution channels may further limit potential US exports to Cuba and deter potential investors.

  

• Customs duties and procedures. As a member of the WTO, Cuba adheres to global guidelines that simplify customs duties and procedures. Cuba’s average applied duty as a percentage of value is 10.6%, well below the average bound rate of 21%t that it has committed to. Furthermore, Cuba is the only Latin American signatory to the International Convention on the Simplification and Harmonization of Customs Procedures (the Kyoto Convention). Because so few Cuban firms are allowed to import and export directly, it is difficult to assess Cuban customs procedures. However, the country depends heavily on food imports and equally heavily on exports to generate much-needed foreign currency. It is therefore unlikely that Cuban customs procedures, while bureaucratic, significantly hinder trade.

• Sanitary and phytosanitary measures (SPS). As a WTO member, Cuba is subject to the WTO’s Agreement on the Application of Sanitary and Phytosanitary Measures. SPS is one of the few Cuban trade measures not visibly affected by political considerations, likely because of Cuba’s heavy reliance on food imports, which supply 60-80% of total food consumption. Only a few cases of SPS problems have been reported in US-Cuba trade since 2000. Although these were minor incidents, any expansion in bilateral trade involves the potential for additional or more problematic issues. However, with US-Cuban diplomatic relations restored, it may be easier to exchange information to resolve trade conflicts involving SPS.

• Infrastructure. Cuba’s infrastructure needs both repair and further development. In recent years there have been successful upgrades to Cuban infrastructure, including the new port of Mariel, the railway expansion to the new port, and telecommunications improvements in certain areas, among others. Because the Cuban government manages most imports and handles the distribution of imported goods within the country, it is difficult to estimate the extent to which poor infrastructure affects trade. Nevertheless, telecommunications connections are still poor, both within the island and to the rest of the world; this is viewed as an obstacle to doing business that affects all foreign firms.