Economic Analysis - Tourism Sector To Underpin Modest Economic Recovery - APR 2017

BMI View : We expect the Cuban economy to return to modest growth in 2017 on higher tourist arrivals, offsetting headwinds related to the end of Petro caribe and poor export dynamics. However, the Trump presidency increases the risk that relations between the US and Cuba deteriorate, undercutting the Cuban tourism sector.

Cuba's real GDP will return to modest growth in 2017 and 2018, fuelled by the tourism sector and an associated uptick in construction. However, the end of oil subsidies under the Petrocaribe programme, alongside subdued prices and declining production in the country's nickel and sugar industries, will place a cap on growth potential. In addition, risks to the tourism sector have grown significantly following the election of Donald Trump, as Trump has threatened to reverse the normalisation in US-Cuba relations we have seen over the past two years.

Though official data is not yet available, Economy Minister Ricardo Cabrisas estimated that real GDP contracted 0.9% in 2016 due to falling exports and a sharp decline in aid from Venezuela, in spite of strong tourist arrivals growth. This figure was well below our growth forecast of 3.0% ( see ' Openness Will Support An Acceleration Of Economic Growth', September 26 2016). As a result, we have significantly revised down our forecasts for growth in the coming years. We now expect growth to reach 1.0% in 2017 and 1.4% in 2018, from 2.9% in both years previously.

Growth To Slowly Recover
Cuba - Real GDP Growth, %
e/f = BMI estimate/forecast; Source: ONEI, BMI

Tourism The Economic Engine, But Risks Have Increased

Tourism will provide the impetus for real GDP growth in 2017 and 2018, though we note that risks to this view have increased following the election of Donald Trump. As we have previously noted ( see ' Tourism Expansion To Significantly Outpace Broader Economy ' , August 2 2016), the detente between Cuba and the US started under former President Barack Obama in late 2014 has sharply increased tourist arrivals to Cuba by loosening travel restrictions on US citizens.

Arrivals Growth Soaring On Improved US Relations
Cuba - Tourist Arrivals, % chg y-o-y
Source: ONEI, BMI

US arrivals fuelled overall arrivals growth of 17.1% y-o-y in 2015. In Q116 tourists from the US surged 93.9% over the same period in 2015, suggesting the sector continued to thrive in 2016. This has attracted increased investment into the sector, with the Cuban government estimating that the country's hotel capacity will grow from 63,000 rooms today to 200,000 by 2030.

However, the Trump administration has increased the risk that the normalisation of relations between the countries will fully reverse in the next several years. Trump has expressed hostility towards the Castro regime, threatening to rollback the progress made under Obama. However, we expect that significant business interests in the US will convince Trump to maintain the current state of affairs with Cuba, allowing the tourism sector to drive growth in Cuba moving forward ( see ' Normalisation Of US-Cuba Relations Will Regress, Not Reverse ' , November 15 2016).

Headwinds Unlikely To Abate

We believe that the forces that undermined growth in 2016 will persist in 2017. First, the ongoing economic and political crises in Venezuela ( see ' Venezuela Crib Sheet: Government Consolidating Position', January 11) have undermined the Petrocaribe programme, through which Venezuela has provided Cuba with deeply discounted oil ( see 'Crude Import Routes Near Historic Shift', July 13 2016). Our Oil & Gas team estimates that Venezuela's total exports of crude and products to Cuba fell 19.5% y-o-y in H116, and have likely deteriorated further in the subsequent months.

As Petrocaribe shipments have supported nearly half of Cuba's domestic oil demand, this has been a heavy blow to the Cuban economy. While Cuba has covered some of the shortfall with increased imports from Russia, the end of Petrocaribe has driven up domestic energy costs, reduced the amount of oil available for Cuba to refine and re-sell abroad, and forced the Cuban government to implement austerity measures beginning in July 2016 as oil revenues fell.

Subsidised Imports Heading Sharply Lower
Venezuela - Petroleum Exports To Cuba, '000b/d

Second, falling prices for Cuba's dominant nickel and sugar exports have resulted in production cuts, reducing net exports from the country. While we expect prices of both nickel ( see ' Nickel: Upward Revisions On Steel Surge ' , November 29 2016) and sugar ( see ' Sugar: Bearish From Spot As Fundamentals Loosen ' , January 12) to trend higher over the next several years, prices will remain subdued by historical standards. This will contribute to an ongoing shortage of hard currency in the Cuban economy, which has in turn forced cutbacks in imported industrial inputs and public investment spending. This will reduce the productivity of Cuba's domestic industries in the years ahead, weighing on the country's growth potential.