Competitiveness and Investment Attractiveness of Cuba as a Foreign Investment Destination

Cuba is a country with a very complicated history and unusual current political situation. However, it has a potential to be an attractive investment destination. The analytical method used are descriptive method, analysis of statistical data, and comparison method of two perspective partners: Cuba and Great Britain. The importance of the topic has increased as Cuba is gaining popularity after relaxation of tensions with the U.S. Now it has an opportunity to become a new investment destination (UK business mission to Cuba, 27-30 April 2015, 2015). The purpose of the paper is to conduct research and analyze how reliable, competitive, and attractive Cuba can be as a foreign investment partner. The report covers the information about Cuba, its investment climate, political risks, cross-cultural risks, economic and financial risks, commercial risks, and recommendations for the country.

The Process of Investment in Cuba

The processes of investment in different counties are stipulated by legal, economic, political, cultural, and other factors that form an investment environment. Therefore, it is necessary to analyze the process of investment in Cuban companies by international investors. Cuba has a specific legal base. Registration of foreign companies, joint ventures with foreign capital and the Law number 77 on Foreign Investment of 1995 governs other features of foreign investment in Cuba (Periu, 2015). There are two possibilities for foreign investors willing to invest in the developing economy of Cuba: investments in partnership with local government agencies or investing without the direct involvement of public institutions. The legislation theoretically allows foreign investment in many sectors with the exception of national security, national defense, education and health. In any case, there is a need for consent of the Executive Committee of the Council of Ministers or a special committee created for this purpose (Periu, 2015).

It is necessary to submit an application to the Ministry of foreign investments, which considers proposals of foreign companies and their Cuban counterparts (usually a local ministry or department) and makes a decision. A positive decision is reached if the circumstances fit the following scheme equity: 51% of the Cuban collaborate (local enterprise, existing or newly created) and 49% of foreign investors (Periu, 2015). Running a business, hiring, salaries, and other internal procedures, are regulated by Cuban legislation too. In recent years, there has been some liberalization of policy and legislation governing the participation of Cuban citizens in the private sector. Now Cubans can open small private businesses: restaurants, shops, beauty salons, etc. and provide professional services on a contract basis (Periu, 2015). Despite the limitations in size, many of these private enterprises are successful and profitable. Moreover, foreign investors support some of them. In this case, the relationship and the contractual obligations of the parties are regulated by personal arrangements, based on mutual trust and legal compromises. Officially, only international notaries abroad may certify these arrangements. This happens because the law has the right to formally engage small businesses in Cuba only to Cuban citizens. This is a real opportunity for foreign investors who have a Cuban partner who lives outside of Cuba (unless they emigrated from Cuba to another country for permanent residence). If a Cuban partner spends a part of their time in Cuba, it is possible to create a formal agreement with them under the laws of the country where they are temporarily living.

Investments may take the form of joint-stock companies in accordance with Cuban legislation with totally foreign capital (exclusive companies), the form of a joint venture (joint-stock company with a capital allocation, usually from 51% to 49% foreign capital share) and trade association (a new entity is not created). Resolution is always obtained for a limited period, after which the company may extend it or declare the liquidation. The Ministry for Foreign Investment and Economic Cooperation (MINVEC – Ministerio para la Inversión Extranjera Cooperación y la Economics) prepares the analysis and the final decision on the establishment of joint ventures. Before submitting the draft, MINVEC needs to have a detailed discussion with Cuban partners.

More than 40 countries invest in Cuba (Periu, 2015). The Cuban government is very suspicious of foreign investors, and controls all of their activities in the country. Foreign investors must meet a number of criteria, including transfer of technology, the provision of capital and new markets. Major investors in Cuba include Canada (extraction of nickel and oil), Italy (telecommunications), and Spain (hotels). Foreign investment has now been linked to more than 34 industries and sectors, the most important of which are the search of raw materials and production of oil, nickel mining and oil, tourism, construction, transport, and communications (Periu, 2015). Except for tourism, the investment can reach 100% participation in the joint ventures, which exist particularly in free trade zones (Figueras, 2013, p. 240). Foreign investment in the tourism sector should not exceed 50% (Thomas, Kitterlin-Lynch & Del Valle, 2015, p. 10).

Progress in relations between foreign countries like Great Britain and Cuba was made possible thanks to Raul Castro’s reforms (Figueredo, 2014). In the beginning of 2008, he took office as the head of state and started the liberalization process. In April Raul Castro allowed the islanders to buy personal computers, in the summer citizens could rent land for ten years (Mesa-Lago & Pérez-López, 2013, p. 25). The new policy allowed self-employment and the list of new jobs consisted of 178 various options, which meant the legalization of small businesses (the number of “self-employed” is now already 496 thousand people or 4.5% of the population) (Johns, n.d.). Cubans got an opportunity to buy and sell used cars, sell real estate, the state banks began to issue loans to individuals and some were free to leave the country. In March 2014, Cuba adopted a new foreign investment law (Law number 118), which regulates the system of privileges, guarantees, and legal protection for investors, defining the areas that are open to foreign investment, forms of foreign investment, banking, foreign trade, employment (Figueredo, 2014). That law clarified the special Cuba tax regimes, the regime of registration and financial reporting, as well as rules relating to environmental protection, the sustainable approach to natural resources use, and intellectual property protections.

Country and Political Risk

Political risks are associated with the following factors of uncertainty that affect the political component of investment activity: the elections on different levels; changes in the political situation; ongoing changes in the state policy; political pressure; administrative restriction of investment activities. There are also such factors as foreign pressure on the state; freedom of speech; separatism; the deterioration of relations between states, which can badly affect the activities of joint ventures, etc.

Cuba is a developing country with a communist regime, and the participation of foreigners and foreign capital in the Cuban economy is strictly regulated by the state. This does not mean that it is impossible to invest in Cuba. However, the investor would have to coordinate their project with government officials. There are certain sectors of the economy, which the Cuban government considers a priority (tourism, telecommunications, transport, etc.), and the chances of getting permission for foreign investment in these areas are much higher. The evaluation procedure of the investment project in Cuba is centralized. After the collapse of the USSR, Cuba’s economic situation has deteriorated (in 1990-1993 the GDP decreased by 33% and analysts predicted the imminent collapse of the Castro government, but by 1994 the situation largely stabilized and the economic condition of the country by international organizations is now estimated as quite satisfactory.

The risks include excessive governmental control and dependence on the strict legal base of Cuba. Opening a foreign representative office in Cuba is subject to trade and investment cooperation with Cuba being carried out not less than three years and the annual volume of such cooperation being not less than 500 thousand US dollars (Smith, 2011). However, the economic authorities of the country can make individual decisions. Permission to open a representative office is issued by the Chamber of Commerce of the Republic of Cuba. If the relationship with a foreign partner will be recognized as a priority for the Cuban economy (for example, a large investment project), it may be allowed to establish a representative office without complying with the general requirements.

Cross-Cultural Risk

Business goes far beyond the national boundaries, drawing into its orbit more and more people with different cultural outlooks. Cultural differences in organizations are beginning to play an increasing role and more influence on the marginal efficiency of business operations. The cross-cultural risks are associated with breaches in compliance and collaboration between two or more countries. In this case, these risks are associated with potential problems in collaboration between Great Britain and Cuba, the investor and recipient. These two states have different regimes, languages, and mentalities. However, the main problem is that Cuba is a socialist republic that engenders controversies in business. Additionally, Cuba is a very corrupt state. Moreover, it ranked 56 in the Corruption Perceptions Index which is higher than some of EU countries (Greece, Macedonia, Bosnia and Herzegovina).

Additionally, Cuba’s language of communication is Spanish while Great Britain uses British English. English is dominant in business collaboration. It is estimated that at least 2/3 of the world’s business correspondence is carried out in this language (Cruz, 2011). However, many countries tend to use their own language exclusively and Cuba is one of them.Therefore, there is a language barrier between the investor and the recipient and translators are necessary. The mentality risk lies in the differences between individualism (Great Britain) and collectivism (Cuba) (Cruz, 2011). Individualism presupposes the man’s actions that define his interests in the first place, which increases the risk. Collectivism, on the contrary, leads to standardization of interests of the market and customers’ needs; it involves the human desire to stick to a certain mode of behavior in a group, which limits freedom, but reduces risks.

Economic and Financial Risk

Economic risk is associated with the uncertainties that affect the economic component of the investment activity in the state and activity of the subject of the economy in the implementation of the investment project within the target. The goal is to achieve general economic equilibrium of the system and the acceleration of the growth rate of its gross domestic product by the production of competitive products, the choice of rational combination of shapes, the industries of state measures on counter-cyclical regulation of the economy, etc.

The advantages of Cuban economy is the tourism industry that attracts foreign investors, export of sugar and nickel, fine cigars, the banking sector, and oil derricks. The weakness is the US embargo that caused lack of access to important markets and investments, as well as the acute shortage of currency. Moreover, Cuba is dependent on fluctuations in world prices for exporting goods. It also has complicated trade restrictions that discourage investment, poor infrastructure, fuel, fertilizers, and spare parts shortages. The main problem of the Cuban economy is that the paternalistic regime of Fidel eliminated both the incentives to work and the punishment for idleness. Therefore, Cubans are not particularly interested in putting in extra effort in their official workplaces.

Economic risks include the state of the economy; budget economy conducted by the state; financial, investment, and tax policies; market and investment conditions; the cyclical development of the economy and the phases of the economic cycle. Other economic risks are government regulation of the economy; the dependence of the national economy; possible failure to fulfill the state’s obligations (partial or total expropriation of private capital, various defaults, termination of contracts, and other financial shocks), etc.

The financial risks specific to Cuba include currency issues. Settlement of foreign trade operations with Cuba companies should be made in freely convertible currencies, except the US dollar. Due to the economic sanctions, supported by the US against Cuba, payments using US banks are not possible. However, in March 2016, the Cuban government has announced the abolition of the 10 percent tax on the use of US dollars in its territory. The US Ministry of Finance has provided Cuban citizens the right to officially receive a salary in the United States and open accounts in US banks (Cuba: Risk Assessment, 2016). Along with the “normal” peso in Cuba, there is convertible peso that is the currency for tourists and diplomats, tied to the US dollar at a level of 1:1 or 25 times more expensive than “regular” peso (Spadoni, 2010, p. 71). Concurrent circulation of two currencies and the requirement for accountants of state-owned companies to equate one peso to another has led to confusion in the trade and financial sectors. There is a plan to unify currencies and standardization of rates must go up to the next Communist Party Congress in April, 2016 (Cuba: Risk Assessment, 2016). The unification will probably be made at 1:10 against the US dollar, which means a tenfold devaluation of the official exchange rate and could lead to instability in the financial market, paralyzing investment in the emerging private sector of the economy.

The next risk is monopoly. In Cuba, there is a state monopoly on foreign trade. The specialized import and export organizations may carry out foreign trade operations in a specific product line or serving specific industries or large state-owned companies. Moreover, there is a special mode of payment of taxes and fees, according to which joint ventures and foreign and domestic investors, who are part of the international economic community, have to pay taxes on profits and use of labor, social security, customs duties, and other fees for road transport and documentation. The level of economic freedom is extremely low. In 2016, Cuba ranked 177 according to the Index of Economic Freedom where only North Korea has a worse position (Cuba: Risk Assessment, 2016). That showed that Cuban economy is repressed. Therefore, the most malicious risks are connected with economic and financial spheres.

Commercial Risk

Commercial risk is a risk of damages or losses in the form of additional expenses or income below the expected one. It is necessary to analyze possible commercial risks associated with the object of investment and the sphere. The object is a hotel, and the sphere is most likely tourism. Tourism in Cuba attracts over 2 million people and is one of the main sources of income for the island nation (Brundenius & Pérez, 2014). Among the factors that affect the popularity of Cuba as a vacation destination is high attractiveness of its natural, historical, and cultural recreational resources (Figueras, 2013, p. 245).

Most tourists visiting Cuba come from Canada and European countries. Most infrastructure (hotels, beaches, restaurants, etc.) is concentrated around Varadero, Cayo Coco, Holguin, and in the state capital – Havana. In 2010, 174,343 tourists from Great Britain visited Cuba (second place after Canada) (World Travel & Tourism Council, 2015). In general, Cuba’s tourism revenues rose over 10.7% by 2015, reaching $ 1.94 billion per year (World Travel & Tourism Council, 2015). In 2016, the Cuban Ministry of Tourism expects to welcome 3.7 million foreign tourists (Cuba: Risk Assessment, 2016). The authorities admit that the hotel business in its current form cannot cope with the influx of tourists. The country has a total of 63 thousand hotel rooms, most of which are concentrated in the capital (Paparelli, 2015). Last October, the Guardian wrote that the hotel rooms in Havana were booked until April, 2016 (Foreign Investment in Cuba: Will Changes Open a Floodgate, 2015).

Cuban authorities expect to increase the number of rooms by 13.6 thousand by 2016 (Foreign Investment in Cuba: Will Changes Open a Floodgate, 2016). Commercial Director of the Cuban Ministry of Tourism Jose Daniel reported that authorities have executed 94 projects with foreign participation and 27 of them were connected to the hotel infrastructure (Foreign Investment in Cuba: Will Changes Open a Floodgate, 2016). Havana is working on contracts with international hotel operators concerning 58 new and existing objects. They is, for example, the establishment of cooperation with the Swiss operator Kempinski and Singapore’s Banyan Tree (Foreign Investment in Cuba: Will Changes Open a Floodgate, 2016). Since 2014, Colombian operator Excelencias and the French department of Warwick International Hotels have been working in Cuba (Paparelli, 2015).

It is very important that investment objects are created according to all rules and conditions. It is necessary to pay attention to the environmental factor. The Cuban government pledged to guarantee the environmental protection to safeguard the environment from the negative impact of the tourism industry. In accordance with local laws, new tourist facilities and related infrastructure should cause minimal harm to the state of nature. In 1994, Cuban government created the Ministry of Science, Technology, and Environment (CITMA), and in 1997, the National Assembly passed a bill on the protection of the environment (“Doing business,” 2015).

Additionally, a number of decrees and resolutions that govern the development of the tourism industry were adopted. At the same time, the decree-law number 212 of the coastal zone management, which establishes requirements for construction on the coast, is of special importance (Spadoni, 2014, p. 45). Solution CITMA 77/99 requires developers to do a thorough assessment of environmental risks, as well as announce the need for licensing (Paparelli, 2015). Therefore, Cuba has additional risks along with its advantages. The advantage is a developed and prioritized tourism sphere. The disadvantages are overly strict environmental requirements and a quickly rising number of consumers with different demands.

The Advantages and Disadvantages of Investing in Cuba, and Recommendations

In sum, the benefits of investment in Cuba are the following: a completely new market, closed for foreign investors previously; wide opportunities for development and improvement; attractiveness for tourists; new legal base. The new foreign investment law allows investment in all sectors, including utilities, real estate (purchase, sale, and rental of homes and offices), hotel management, and professional services. The law also provides for investments in shares and other securities or bonds, whether public or private, that are not classified as direct investment. Foreign investments in health, education or any institution of the system of the armed forces are also banned. In addition, foreign investment is prohibited in spheres, which may threaten the national security and defense, the preservation of national resources and the environment. In addition, the law on foreign investments presupposes reduction of the income tax twice from 30% to 15% for most industries as well as to cancel the 25% tax on labor costs (Spadoni, 2010, p. 74). Cuba now allows 100 percent foreign ownership, which, although is stated in legal provisions, has never been applied in practice. Joint ventures that are parties to the treaty on the International Economic Association and companies with 100 percent foreign capital have the right to import and export goods and services within the framework of its objectives (Alexander, 2016).

Investors in joint ventures will receive exemption from all income taxes for a period of eight years. Investments in real estate can be made in the private sector. Cuba now offers new control measures to assess compliance with legal rules and conditions approved for the creation or implementation of any business. More stringent measures of environmental management were provided. Individuals or corporations responsible for causing damage to the environment will have to restore the previous environmental situation, and if necessary, repair the damage or pay appropriate compensation.

Cuba also recognizes the rights of the foreign investor’s intellectual property and technological innovation. However, the main risks are associated with the economic and financial spheres. The problems are monopolization, government control, problems with two-level currency system, problems with the U.S. currency and banks and others. Moreover, all forms of investment need to be officially registered by public authority, and then they should be verified by a notary and added in a special register. The number of foreign companies willing to work in Cuba and invest there was shrinking: from 400 companies in 2000 to around 200 foreign enterprises in 2015 (Claver-Carone, 2015).

University of Michigan estimates Cuba’s rating as D level, which is the highest political and economic risks (Cuba: risk assessment, 2016). Now, out of the “big three” rating agencies, only Moody is working with Cuban bonds (Moody’s changes Cuba’s outlook to positive from stable; Caa2 rating affirmed, 2015). According to the company, their rating is Caa2, which means the obligation of very poor quality with extremely high risks (Moody’s changes Cuba’s outlook to positive from stable; Caa2 rating affirmed, 2015). In December 2015, the agency raised the rating outlook from “stable” to “positive”, explaining the two factors that include the reduction of financial dependence on Venezuela and active rapprochement with the United States (Moody’s changes Cuba’s outlook to positive from stable; Caa2 rating affirmed, 2015).

Recommendations

A means of resolving possible investment risks are avoiding, retention, transfer and reduction of risk. Avoiding risk is simply an evasion of the event associated with the risk. However, avoiding the risk for the investor often means losing his income. Risk retention is when an investor keeps responsibility for risk. Transfer of risk means that the investor transfers the responsibility for the risk to someone else, such as an insurance company. In this case, the risk of transmission is by his insurance. Reducing Risk is reducing the probability and amount of loss. To reduce the risk level, investors can use various methods, of which the most common are: diversification, acquisition of accurate and complete information, limiting, self-insurance and insurance. The first recommendation for NBS Global Inc. is learning about Cuba and its investment climate and environment. This aspect must come beforehand as Cuba has many drawbacks and obstacles for foreign investors.

The second recommended way to reduce risk but keep profitability is insurance or self-insurance. Self-insurance means that the company relies on itself instead of buying insurance in the insurance company. Thus, it saves the money otherwise spent. Self-insurance is a decentralized form of creating natural and financial insurance funds (reserve) directly in the economic entity, especially which work is exposed to risks.

The third option is to find a reliable partner that Cuba is dependent on (as German company made a deal with Tabacalera, main tobacco-importing overseas (Spanish) country). To eliminate banking issues, NBS Global Inc. should find the reliable non-US bank to transfer money. In this situation, a good point is that the company is using suitable currency (twenty million British pounds). Therefore, there are three main recommendations for NBS Global Inc. to invest in a hotel. They are finding a reliable partner, a bank and learning everything about Cuba, as well as its legislation to adjust and be prepared.

Conclusion

In conclusion, Cuba is a peculiar investment partner and its being a competitive foreign investment partner is controversial. The benefits of investing in Cuba is labor force, new market, no influence of the United States, the relaxation of governmental control, new opportunities to develop and increase the quality of hotel and touristic services. However, all statistical data and analysis of political risks, cross-cultural risks, economic and financial risk, and commercial risks described Cuba as not the best place for investment. The risks include government control over the economy, monopolization, problems with currency, non-acceptance of the U.S. banks and currency, language barrier, too strict environmental requirements, socialistic mentality etc.

Probably, the recommendations to find a partner, a reliable bank and learning about Cuba as much as possible would help a company that wants to invest in a hotel, as the tourism industry is critical to Cuba. Without knowing the investment risks associated with Cuba, the company would experience enormous losses and unpredictable obstacles. The most interesting point is that nowadays Cuba is trying to establish relations with the U.S, to mollify internal policy and attract investors. Therefore, it is necessary to follow current news and build strategy according to the latest conditions.