Political Change To Come Despite Legacy Of Intransigence

BMI View: The Cuban political system is tightly controlled by a small number of individuals, many of whom are of an advanced age, which presents significant scope for uncertainty over the coming decade. Internationally, Cuba has begun to reposition itself with a view to greatly increasing its engagement with international markets, a strategy that will be supported by the US's softening of policy towards the island.

We believe that the next decade will be a time of substantial change and political uncertainty in Cuba, despite the fact that President Raúl Castro and his brother Fidel have already begun to make preparations for their eventual departure from the political scene, handpicking loyalists and eventual successors to ensure ideological purity and continuity.

Political power in Cuba is highly concentrated in the hands of just a handful of people, particularly the Politburo of the Communist party. This body of 15 people has six members over the age of 75. Raúl Castro's current presidential term (which he has stated will be his last) ends in 2018, after which it appears likely that First Vice President Miguel Díaz-Canel Bermúdez will take the helm. While Díaz-Canel is considered a hardliner by many observers, we believe that there is a growing consensus within the Cuban political leadership that the country needs to follow a more pragmatic path in the years ahead, and we expect the end of the Castro brothers' era to mark a major turning point in Cuban politics. However, given the scope of the challenges that are in many ways at odds with still-entrenched ideological impulses, we expect that, compared with those of its regional peers, Cuba's business environment will remain poor for many years to come, and the uncertainty both at home and abroad that will accompany this state of political flux will present its own challenges.

A Demographic Anomaly
Cuba - 2014 Median Age & Population Growth

Political Change To Come Despite Legacy Of Intransigence

BMI View: The Cuban political system is tightly controlled by a small number of individuals, many of whom are of an advanced age, which presents significant scope for uncertainty over the coming decade. Internationally, Cuba has begun to reposition itself with a view to greatly increasing its engagement with international markets, a strategy that will be supported by the US's softening of policy towards the island.

We believe that the next decade will be a time of substantial change and political uncertainty in Cuba, despite the fact that President Raúl Castro and his brother Fidel have already begun to make preparations for their eventual departure from the political scene, handpicking loyalists and eventual successors to ensure ideological purity and continuity.

Political power in Cuba is highly concentrated in the hands of just a handful of people, particularly the Politburo of the Communist party. This body of 15 people has six members over the age of 75. Raúl Castro's current presidential term (which he has stated will be his last) ends in 2018, after which it appears likely that First Vice President Miguel Díaz-Canel Bermúdez will take the helm. While Díaz-Canel is considered a hardliner by many observers, we believe that there is a growing consensus within the Cuban political leadership that the country needs to follow a more pragmatic path in the years ahead, and we expect the end of the Castro brothers' era to mark a major turning point in Cuban politics. However, given the scope of the challenges that are in many ways at odds with still-entrenched ideological impulses, we expect that, compared with those of its regional peers, Cuba's business environment will remain poor for many years to come, and the uncertainty both at home and abroad that will accompany this state of political flux will present its own challenges.

Communists Cut Adrift Still Redefining Cuba's Path

Recent economic reforms bolster our view that policymakers in Cuba will seek to liberalise the economy in the years ahead, although even after a period of significant change following the collapse of the Soviet Union, the political establishment has struggled to define a concrete economic and political trajectory.

Cuba was a close ally of the Soviet Union, and the latter's collapse and cessation of financial support ushered in what is known euphemistically as Cuba's 'Special Period'. This stretched from the early-to-mid 1990s, when the country experienced widespread famine and economic hardship. Reduced financial support also necessitated significant economic reforms, including policies encouraging the inflow of foreign currency, and allowing foreign ownership of property for the first time.

Nevertheless, the political system retains much of the Soviet-style intolerance of dissent, and human rights groups estimate that thousands of political prisoners are arrested every year. Arrests are often used to pre-emptively dissuade activists from participating in events or voicing criticism, and prisoners are often released shortly after being jailed. Due process is severely lacking and, according to Human Rights Watch, courts are 'subordinate to the executive and legislative branches'. Laws are unevenly implemented, and are often enforced for political purposes or for low-level extortion. Expropriation of foreign-held assets is still a major risk to businesses operating in the country, despite recent efforts to appear more accommodating to potential investors. The government controls the media and tightly restricts access to other information. While independent bloggers, political campaigners and other activists have managed to rally a growing number of pro-democracy supporters, they are subject to near-constant harassment by the government, which still enjoys a near-monopoly on political messaging. The Communist Party is the only party legally allowed to campaign during elections, and only one candidate is permitted per constituency of the National Assembly (if the single candidate is unable to get 50% of the vote, the post remains vacant).

While rhetorically maintaining communist ideals, the Cuban government has acknowledged that greater foreign investment is critical to the country's future, and has courted bilateral investment from Brazil (which has committed to upgrading Cuban ports), Mexico (which has agreed to help develop Cuba's energy sector), Venezuela (an ideological ally that has supported the government with billions of dollars since the beginning of the Hugo Chávez era), and other countries in Latin America.

In light of the small steps towards reform already taken by the Cuban leadership, and its stated admiration of the performance of states such as China and Vietnam - which have nominally communist governments but have prospered under more market-friendly policies - we are optimistic that the situation will gradually improve. A long-term strategy for economic development of the island is critical to maintaining the legitimacy of the government, and to helping support an ageing population. However, the path will be long and is likely to be fraught with setbacks given the spirited and perennial debate within the Cuban political establishment over what constitutes a betrayal of Cuban identity versus what is an acceptable effort to improve the current system. Given the government's commitment to maintaining centralised control of the economy, Cuba ranks last in the region and second to worst in the world in the 'market orientation' component of BMI's Business Environment Ratings with a score of 13.2/100 (only North Korea ranks lower among the 179 countries for which we compile ratings).

A Demographic Anomaly
Cuba - 2014 Median Age & Population Growth

The US Embargo: Elephant In The Room

One of the most important considerations for any future Cuban policy is the country's relationship with the West, particularly the US, and we expect progress on this front to be incremental but positive in the years ahead. The US embargo on Cuba, which has lasted more than half a century, remains a major impediment to Cuban growth, given the close proximity of the Caribbean nation to the world's largest economy, and the untapped potential for goods exports, tourism, and investment. At the UN General Assembly, Cuba regularly pushes for international condemnation of the US embargo, and support for its cause has become nearly unanimous.

The Obama administration has intimated that it wants to soften the US's stance on Cuba, announcing modest reforms, including the easing of restrictions on travel and remittances. However, the pace of change has been a major disappointment for the Cuban government. For its part, Cuba has taken some modest steps towards liberalisation, which have been welcomed by the business community and proponents of greater engagement with the island nation. Since January 2013, most Cubans are no longer required to obtain 'exit permits' to leave the country, a reversal of a long-standing policy aimed at retaining skilled professionals, particularly doctors. The policy is symptomatic of President Raúl Castro's more moderate stance. The younger Castro, brother of former leader Fidel, has also loosened property laws, allowed a greater number of non-state-run enterprises, and announced an intention to abolish the market-distorting dual currency system, by which citizens use one peso (pegged at CUP25.00/USD), while another 'convertible' peso is used by visitors and tourists (pegged at CUP1.00/USD). State media announced in October that authorities would work to unify the currencies to boost growth and promote greater economic efficiency. We expect the policy to be enacted, but only gradually, to minimise inflationary and other effects of the much weaker exchange rate.

International Opinion Unequivocal
Cuba - UN Vote Breakdown On Resolutions Condemning The US Embargo On Cuba

Importantly, opinion on the embargo in the US has shifted dramatically in recent years, providing the political space for a future change in policy. A majority of Americans and, crucially, even a majority of Cuban-Americans, now support the resumption of diplomatic relations and an end to the embargo. This marks a significant change from less than 20% in support of such a policy two decades ago. We believe that American policymakers are waiting for an opportunity to substantially normalise relations, and that the end of Castro rule (either by death or voluntary succession) is likely to provide such an opportunity within the next decade. The wording of the US embargo states that it cannot end if a Castro is at the helm. In the event that the embargo is lifted or sanctions are otherwise substantially eased, we expect the economic dividend to be very large and potentially fundamentally transformative for the Cuban economy.

Better The Devil You Know?

Despite our belief that Cuba's political situation will become more favourable over the long term, the fact that the country's leadership will be experiencing a transitional stage, following decades of Castro rule, informs our view that uncertainty will weigh on investor sentiment over this period. Cuba therefore ranks near the bottom of the region in its Long-Term Political Risk Rating, with a score of 50.7/100. It scores particularly low in the 'characteristics of polity' sub-component, with a score of just 16.4/100, owing to its system of government and poor track record respecting the rule of law.

Risks To Outlook

While our core scenario assumes that the modest reforms enacted by the Cuban authorities in recent years are indicative of a broader shift towards more market-friendly policies, we acknowledge that some within the country's core leadership are more ideologically ensconced than others. Should these factions emerge as the dominant players in a post-Castro regime, our view for a gradual improvement in the business environment may prove overly optimistic. Furthermore, US politics has been characterised by increasing polarisation in recent election cycles, and if US-Cuban relations were seized by one party as a wedge issue, it could become politically less palatable for an administration to ease sanctions at the pace we currently envisage.

Table: Political Overview
System of Government One-party autocratic republic with power vested largely in the Communist Party's 15-member Politburo
Head of State President of the Council of State of Cuba Raúl Castro
Head of Government President of the Council of State of Cuba Raúl Castro
Last Election National Assembly of People's Power - February 3, 2013
Key Figures First Vice President - Miguel Díaz-Canel Bermúdez; Minister of Economy and Planning - Adel Izquierdo Rodríguez; President of Central Bank - Ernesto Medina Villaveirán
Main Political Parties Partido Comunista de Cuba (PCC) (612 seats): only party allowed to rule Cuba. Although other parties may exist, they may not campaign nor hold seats in the National Assembly.
Next Election National Assembly - 2018
BMI Short-Term Political Risk Rating 79.6
BMI Structural Political Risk Rating 50.7
Source: BMI
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