The stigma attached to Fidel Castro’s regime means that few private businesses will talk publicly about their operations – or intentions – in Cuba. But an increasing number of investors are gearing up for a taste of a post-Fidel regime as the communist state moves tantalizingly closer to economic reform.
Indeed, many emerging market observers expect Raul Castro, Fidel’s younger brother, who took over as interim leader last summer, to introduce market-friendly policies in the near future, unleashing a torrent of foreign investment into the country.
For the fixed-income specialist, this means there has never been a better time to buy Cuba’s sleepy yet highly profitable non-performing debt, with prices that are expected to soar in the secondary markets if and when Raul relaxes investment restrictions. “This is a bid-only market, so even if Raul opens a small window of investment opportunity, there’s a massive chance that huge capital injections will flow into Cuba,” says Peter Bartlett, managing director of Exotix, an investment firm that trades distressed Cuban debt.
Still, Cuba’s sovereign debt market won’t fully take off until the country pays its $12 billion outstanding debt bill and normalizes commercial relations with the US, which have long been paralyzed due to a trade embargo. Of course, there is still a chance that 80-year-old Fidel, who is rumoured to have cancer, could recover and swing back to power, burying hopes of a market transition in Cuba – at least in the short term, observers say.
Optimism
Yet there’s growing reason to believe that Raul will pave the way for foreign capital to flow into the island in the next year or two. A new generation of young and more commercially-oriented politicians is emerging in Cuba, pressuring Fidel Castro’s communist regime to orchestrate a transition into a more market-friendly government or risk losing power. Some say this could prompt Raul Castro to open up the economy, China style.
“Raul is going to have to give them bread as opposed to circuses,” says Brian Latell, a US-based Cuba analyst, who argues that the younger Castro will want to harvest the fruits of overseas investment.
“Both brothers are worried that they need to provide a door to a new type of economic regime instead of facing an abrupt government change,” says an executive at a US-based investment firm. “They realize that governments who managed transitions effectively [such as China and Vietnam] are the ones who ended up staying in power.”
Cuba also needs billions to modernize its rickety infrastructure and bring progress to the impoverished island, which has Latin America’s lowest per-capita income. Though Venezuela has provided a lifeline in the form of economic aid, helping to rev up the economy (which grew 7.5% in 2006), it pales in comparison to the backing Cuba used to receive from the Soviet Union.
Cuba stopped paying its sovereign debt in 1986, which is held by European and Latin American banks. The London Club, an investment vehicle made up of European banks, has roughly $1.25 billion of the state’s non-performing debt, including the popular Credit Lyonnais syndicated loan, which trades at $15-15.50 per 100 basis points, according
to Exotix.
While market pundits expect secondary bond trading to pick up if Raul begins reforms, they don’t think the debt market will boom until Cuba redeems or restructures its sovereign paper. “They are under increasing pressure to pay their debt,” says Bartlett. “They have been trying to issue new debt, but nobody wants to touch it.” He adds: “Cuba has to restructure its London Club debt before it can issue more bonds. If it does this, it will open a whole new range of investment opportunities. It will revolutionize the market.”
Neighbourhood watch
But even if it does this, Cuba’s debt will have limited buyers until US investors can access it, analysts say. With Miami’s coast beckoning less than 100 miles away, the US is home to Cuba’s largest potential investor base.
“As long as US investors are kept off Cuba, the investment universe is going to be very limited,” says an emerging markets analyst with an investment bank in London. The US embargo also hinders non-US funds from investing in Cuba, he adds. “You can be a fund domiciled in the Cayman Islands or Jersey, but if one of your founding partners is American, the US government could go after you.”
The Bush administration is under pressure to soften its Cuban policy, which it recently hardened, amid mounting criticism from both Republican and Democrat officials that the agenda is “plain dumb”, making little commercial sense. But if or when the US will change or remove the embargo is anyone’s guess. Change could come in the 2008 elections, but some argue that Fidel Castro will have to disappear before there’s any breakthrough. “Cuba is being treated alongside Iran as an extended axis of evil and treated accordingly,” says an investment bank analyst. “I don’t think there’s going to be a major change until Castro dies.”
Still, expect a big party when US investors can reach Cuba. “There is no secret that Cuban debt is one of the cheapest in the world,” Bartlett says, adding that only Sudanese bonds are slightly cheaper, while Ivory Coast debt costs twice as much. “If American investors gain access, prices could soar three to four times overnight.”
Walter Molano, head of research at BCP Securities, says the US government needs a rethink on Cuba, whose untapped $40 billion economy and highly educated workforce will bring unprecedented investment opportunities in the post Castro era. “This is the biggest Caribbean country and potentially its biggest economy. The US could dominate many promising sectors such as media, telecoms, tourism and finance. They are missing out.”