Economic Impact of the New Cuba Measures

This post takes an initial look at economic implications of the new measures announced by President Obama on December 17, 2014.  The author estimates the one-year positive impact of the measures at 0.5% to 0.6% of Cuba’s GDP with the second year impact somewhat higher because of multiplier effects.<1>  The impact although significant will by itself not rescue Cuba’s economy from stagnation in the absence of major policy improvements and of changes to US laws restricting trade, tourism and finance with Cuba.  US exports could increase substantially albeit from a low base as some of the rising transfers and expenditures by US residents are used to finance US purchases.  A 1/3 use of these funds could increase US exports by 42%. The new Cuba measures will have an impact within the next two years especially because of the enhanced remittance allowances.   Easing of bureaucratic rules for some US visitors will have a lesser impact.  Important are rising expectations following Mr. Obama’s announcements involving the longer horizon for trade and investments.   However this would have to be accompanied by decisive changes in economic policies in Cuba and not only wait for a lifting of American laws imposing trade, tourism and financial sanctions. The main changes announced include the reestablishment of diplomatic relations uplifting the profile of Cuba in the eyes of the international business community, the rise in the allowance for remittances by Cuban Americans to their relatives in Cuba from $500 to $2000 per quarter and the sharp reduction in the paperwork needed for US visitors to travel to Cuba under 12 categories specified in current law.  Further measures comprise allowing US banks to establish correspondent relationships with Cuban banks,  authorization for US visitors to use credit and debit cards and lifting the minimum amount of goods that can be brought back by US visitors. American exporters will also be able to broaden the range of merchandise that can be sold in Cuba to include telecommunications equipment, construction and farm inputs among others. This comes at a time when the Cuban economy is stagnant with difficult prospects ahead for export growth and foreign investment.  Exports of goods and services stagnated in 2013 according to official statistics.<2>  In the five years to 2012, the most dynamic element of exports have been the supply of medical and other services.  These services are centered on Venezuela and other oil exporting nations such as Angola, Algeria and Saudi Arabia.  Weakness in oil prices and widespread economic mismanagement in Venezuela are leading to a sharp fall in services export revenues in 2014 and likely in 2015.  Another leg of the government’s growth strategy, a new opening to foreign investment is getting nowhere soon, largely because the government’s caution in allowing new projects, its reputation as an inconsistent regulator and guarantor of contractual obligations, controls of prices and labor markets and the closure of the US to Cuban exports and shipping.  A question is whether or not the announced changes will offset the negative external currents facing the economy. A precise assessment of the impact of the measures is difficult given uncertainties about implementation and regulations in both countries.  At the least a rough estimate for the two year impact of the new measures’ impact on trade and finance can be established.  These estimates provide a sense of the relative magnitude of the impact. SHORT-TERM IMPACT The three most important items of the economic opening involve remittances, visitors to Cuba and exports from the US.  These elements are sustained by an easing of US controls and changes in rules involving money transfers and bank transactions. Remittances Remittances are today the most important element in the economic relation between US and Cuban residents.  There are no official figures, but  estimates by Emilio Morales of The Havana Consulting Group indicate that cash remittances in 2013 reached $2.8 billion and remittances in kind were some $3.5 billion.<3>  This estimate obtained from sampling and retail data also indicates that about 1.1 million Cuban-Americans were involved in sending cash remittances which yields an average of slightly over $2500 per person.   This compares to the existing annual limit of $2000 to any one Cuban national per remitter.<4>  The new limit of $8000 per person will amply cover the gap.  There is no way to precisely forecast how much of the higher allowances will translate into higher remittances as this depends on funding availability by remitting relatives. To the extent cash remittances are used to finance small business operations the impact will also vary with the ease with which Cuba will allow financing for equity and working capital in these firms.  During 2007-2013 cash remittances increased at an average yearly rate of 12.6% though in 2013 the annual rate was 6.6%.  Some of the slowdown can be attributed to the official limit.  As a working hypothesis for purposes of calculations here, we take the excess supply of 25% over the limit as an indication of potential expansion of remittances equivalent to 12% per year for the next two years, a rate close to the average growth of the last six years. Approved US visitors to Cuba Official data shows that 92,348 non-Cuban US residents visited the island in 2013 as against 98,050 in 2012.<5>  These comprise individuals in 12 categories authorized by law to visit Cuba.  It appears the lower number last year was the result of delays arising from the licensing process involved in the program administered by the Office of Foreign Assets Control of the US Treasury.  The new regulations will only require general licensing and implementation directly by the entity organizing each trip.  This should boost visits by US residents.  At the same time allowing use of US credit and debit cards will facilitate payments.  This also applies to Cuban-Americans visiting relatives in the island.  Maximum allowed expenditure is the State Department’s per diem of $188 for Havana, $147 for Santiago and less for other locations.  Using these numbers and average stay rates for all visitors to Cuba indicates outlays of a little under $100 million for these visitors in 2013.<6>  So the monetary impact of even a doubling of visitors is small compared to remittances.  The calculation below assume a range for these outlays between doubling in one year or in two years. US Exports to Cuba American exports to Cuba are restricted to foodstuffs and medical products and have been declining steadily since their peak in 2008.  Last year exports were $359 million compared to $464 million in 2012 according to US Department of Commerce data.<7>  In the first 10 months of 2014 exports fell 22% to $260 million.  The declining trend comes about from displacement of American products by imports from Brazil, Vietnam and other nations and by strained international liquidity in Cuba.  This year lower prices of farm products are also contributing to the soft numbers.  Payment in cash required by US law also places exporters at a disadvantage.  While the new measures will not allow credit a new definition of “cash in advance” will allow trade to take place upon documentary collection.  This will provide more guarantees to  the Cuban importer and facilitate the banking transaction.  In this context US banks will in the future be allowed to open correspondent relationships with Cuban banks eliminating the need for third-country banks in many transactions.  Cuba’s weak external financial position does not augur well for US exports in the near term particularly as concessionary official financing is available from competing suppliers in Brazil, China, Vietnam and others.  As a working hypothesis it is reasonable to assume that part of the increase in net inflows from remittances and US visitors may be used to finance US imports.  Use of 1/3 of these funds would lead to a  $130 million or a 42% increase in US exports of goods in the first year. Overall Short-Term Impact The considerations above imply an increase of around $400 million per year in services from and transfers to Cuba.  There are additional benefits in terms of remittances in kind and increased spending by Cuban-American visitors because of easier payment mechanisms.  These are more difficult to quantify but will probably amount to a much smaller figure than the gains attributed to the measures on remittances. These numbers would amount to an annual impact of around 0.5% of GDP in the first year and a bit more in the second year because of multiplier effects.  A more rapid increase of US visitors so that the number doubles in the first year would add another 0.1% of GDP to this estimate. The impact of the new measures will not by themselves change Cuba’s path of slack output and productivity growth although relative to the low 1.4% real GDP growth expected for 2014, the change becomes quite relevant. LONGER-TERM IMPACT The longer horizon for Cuba would be much  enhanced in case the trade, tourism and finance restrictions embodied in US law were to be lifted.  Such estimates are beyond the scope of this note.  A key element for the longer term is the impact on foreign investment.  This in turn will depend on prospects for implementation of policies in Cuba that improve substantially the operating environment for foreign firms.  Today such changes are not evident in spite of revised legislation enacted in early 2014, and foreign direct investment is placed at around 1% of GDP.   It is estimated that to reach government growth targets foreign direct investment will have to increase to at least 3.5% of GDP.<8>  The recent measures announced by Obama are not sufficient to accomplish this.  Further easing of US restrictions could generate sizable investments in sectors such as tourism and mining that can operate in relative isolation from domestic markets.  However  the economy remains distorted by central planning, pervasive controls on prices and wages and discretionary regulations that hit large and medium sized enterprises.  Foreign investment in sectors such as tourism and mining will likely yield a growth upsurge but not sustained expansion in the absence of broad reforms to establish working product and labor markets and a balanced regulatory framework. <1> The effect however is substantial in comparison with an expected rate of real GDP growth of 1.4% for 2014. <2> Oficina Nacional de Estadisticas, Cuentas Nacionales 2013, indicate that exports of goods and services reached 18.59 billion pesos in 2013 versus 18.65 billion in 2012. <3> “Emigrados cubanos enviaron mas de 3500  millones de USD en remesas en especie en el ano 2013”, thehavanaconsultinggroups.com <4> Department of the Treasury, Office of Foreign Assets Control, “ What you need to know about U.S. sanctions against Cuba”. <5> Oficina Nacional de Estadisticas, Anuario Estadistico 2013. <6> These calculations do not include Cuban receipts for processing fees, international flights and licenses.  A 30% mark-up is assumed in the calculations below. <7> Census Bureau, US Department of Commerce data bank. <8> Luis R. Luis, “Cuba’s Growth Strategy Features Human Capital and Foreign Investment: May it Work?”, ascecuba.org/blog, April 19, 2004.