Economic Analysis - Mounting Headwinds To Constrain Growth - SEPT 2017


BMI View : We expect Cuba's economic growth to decelerate over the coming years, despite a steady performance in the first half of 2016. Deteriorating relations with the US and an end to subsidised oil imports from Venezuela will act as the primary headwinds to growth moving forward s .

We expect that revised US policy and the ongoing crisis in key ally Venezuela will weigh on Cuba's economy in the coming years. Though government reports indicate that the economy grew 1.0% in H117, we expect that headwinds will rise over the second half of the year. As a result, while we forecast Cuban real GDP to return to growth in 2017, coming in at 1.0% after a contraction of 0.9% in 2016, we expect growth will decelerate to 0.7% in 2018. This is a downgrade from our previous forecast of 1.4%, which was based on the assumption that the US would not roll back relations with Cuba.

Set To Deteriorate In 2018
Cuba - Real GDP Growth, %
e/f = BMI estimate/forecast. Source: ONE, BMI

US Policy Changes To Weigh On Tourism Sector

New restrictions set to be imposed by the Trump administration will likely result in a drop-off in tourist arrivals to Cuba ( see 'Rollback To Undermine Cuban Economy', June 16). The administration will ban so-called 'people-to-people' travel, which allowed US citizens to travel independently to the island. Moving forwards, travel can only be conducted within authorised groups and for a limited number of purposes. In practice, the new restrictions will reduce the number of transactions between US tourists and the private sector in Cuba, which had provided Cuban businesses with a substantial supply of US dollars. As a result, we expect that the new policy will be a blow to private demand in Cuba in the months ahead, while also reducing revenues at hotels and businesses owned by the Cuban government.

However, we still expect tourism to remain a key driver of the Cuban economy in the coming years. Travel to Cuba by US citizens is still permitted, though in a limited form and both air and cruise lines will still be allowed to service the island. Additionally, the US is only one of a number of key source markets for Cuba. The US only accounted for 7.0% of arrivals in 2016, the most recent official data that is available. Similarly, though arrivals grew 13.5% y-o-y in 2016 the US only accounted for 3.4 percentage points of that rise. We expect that other markets, particularly Canada and Western Europe, will support steady growth in the sector moving forwards.

Investment To Take A Blow

The Trump administration's ban on doing business with the Cuban military will weigh on investment into the island. The Cuban military conglomerate, Grupo de Administracion Empresarial SA (GAESA), is involved in most sectors of the economy. As a result, US businesses will have greatly limited scope for investment into Cuba. In addition to the new regulations, the uncertainties created by the abrupt reversal of US policy will discourage investment from US-based companies.

We expect that the reduction in foreign investment will fall most heavily on Cuba's tourism sector. The recent boom in arrivals has fuelled substantial investment in tourism-related construction projects. However, under the newly revised rules, we expect interest in Cuba from US hotel chains will fall ( see 'New Restrictions To Discourage Tourism-Related Investment', June 20). Additionally, the Cuban government is likely to put on hold its previously announced plans to expand the island's hotel capacity.

Venezuela Support Dries Up

Declining support from Venezuela, in the form of heavily subsidised oil imports, will act as a significant headwind to growth in the coming quarters. Leaked reports from Venezuela's state-owned PdVSA show that fuel deliveries to Cuba have fallen nearly 13.0% in H117, contributing to gasoline and electricity shortages. While the Cuban government has cut back on usage by state-owned companies, falling support will require the island to acquire fuel at market prices. In addition, it will prevent the government from re-exporting the fuel, undercutting a key source of revenues.

Moreover, the oil deal between the two countries was based in large part on geopolitical considerations, as Venezuela sought to use its oil wealth to support its ideological allies throughout Latin America and the Caribbean. However, we expect that the government of President Nicolas Maduro will be forced out before the end of his term in early 2019 ( see 'Assessing Political Outcomes: Regime Change Remains Most Likely Scenario', July 14), likely replaced by a democratically elected government less sympathetic to Cuba. As a result, the island will no longer receive subsidised oil in the event of regime change in Venezuela.

Reform Efforts Likely Pushed Back

We expect that mounting economic headwinds will cause Cuba to push back the timetable for long-promised economic reforms, most notably currency unification ( see 'Currency Unification After Leadership Transition', May 3). This will be driven by political considerations: Raul Castro has announced that he plans to step down from the presidency in February 2018, marking the first time since 1959 that a non-Castro will officially lead Cuba. As the country transitions to a new generation of leaders amid decelerating economic growth, we do not think that the Partido Comunista de Cuba will risk pursuing potentially destabilising reforms. As a result, we expect that most reform efforts will likely be put on hold until H218 at the earliest.

Macroeconomic Forecasts (Cuba 2013-2019)
Indicator 2013e 2014e 2015e 2016e 2017f 2018f 2019f
National Sources/BMI
Population, mn 11.4 11.4 11.5 11.5 11.5 11.5 11.5
Nominal GDP, USDbn 77.1 80.7 87.1 89.5 93.2 14.9 8.4
GDP per capita, USD 6,760 7,050 7,602 7,801 8,116 1,296 732
Real GDP growth, % y-o-y 2.7 1.0 4.4 -0.9 1.0 0.7 1.4
Consumer price inflation, % y-o-y, ave 3.0 3.0 3.0 3.0 3.0 3.0 3.0
Exchange rate CUP/USD, ave 1.00 1.00 1.00 1.00 1.00 6.50 12.00
Exchange rate CUP/USD, eop 1.00 1.00 1.00 1.00 1.00 12.00 12.00
Budget balance, CUPbn -2.6 -1.7 -4.4 -7.2 -11.3 -11.0 -10.6
Budget balance, % of GDP -3.4 -2.1 -5.1 -8.0 -12.1 -11.3 -10.5
Current account balance, USDbn 0.6 2.4 3.2 3.3 3.4 0.5 0.3
Current account balance, % of GDP 0.8 3.0 3.7 3.7 3.6 3.6 3.5