Aug 14, 2015

Nearly eight months have passed since President Obama announced that the United States (U.S.) would begin lifting the decades-long embargo against Cuba. Under this new policy, Americans can purchase certain goods produced in Cuba’s emerging private sector and engage in limited financial transactions for the first time in over 50 years. Many welcome the changes in America’s policy. Yet, arguably, the reforms already underway in Cuba will have a greater impact on the lives of Cuban people than these American changes. Foreign investment and financial services infrastructure to support this investment will increase dramatically over the next couple of years as they open their doors and operate in the global financial markets. The impact both within Cuba and across the major financial centres will require large-scale infrastructure change creating tremendous opportunities.

Pre-Embargo

Prior to the events leading to the U.S. embargo in 1960, Cuba’s financial sector was quickly developing. The first national credit bank was established in 1950, encouraging investment in agriculture and industry by offering loans to small-scale entrepreneurs at affordable interest rates. Throughout the 1950s, Cuban banks began emerging as viable alternatives to the dozens of foreign banks that had been operating in the country since 1898, clearly demonstrating the Cuban potential for independent financial progression.

The Castro Years

Cuba’s flourishing financial sector came to an abrupt halt in 1960 when Fidel Castro’s regime nationalised all banks and private enterprise, leading to America’s trade embargo. Cuba became even more isolated as it withdrew from international institutions, namely the International Monetary Fund and the World Bank. After the loss of its key trading partner, the Soviet Union, Cuba entered a severe economic crisis in the early 1990s. Without a means of financing its growing deficit, the Castro regime resorted to printing more pesos, further decreasing the currency’s value. In the wake of the ensuing inflation, demand for the U.S. dollar increased, leading to the Castro regime introducing a second currency pegged to the U.S. dollar.

Reform

After the crisis of the early 1990s, Cuba’s leaders understood reform was essential for economic stability. Starting in 1995, the government cautiously began introducing reforms to the country’s banking system that, under the Communist regime, had functioned almost solely for state purposes. In 1997 a decree was issued to establish a new Central Bank, with the hope of attracting foreign direct investment. In the same vein, Cuba also began encouraging foreign banks to establish (or re-establish) branches in Cuba. Under Raul Castro’s leadership, the government has continued these reforms by lifting the decades-long moratorium on the sale or purchase of homes and cars, and introducing a credit policy allowing private sector workers to apply for loans.

The government has announced its intention to end the complicated dual currency system, and is expected to do so by the end of this year. Some applaud the transition as a means of facilitating business transactions although wealthier Cubans fear currency devaluation. Monetary policy reform is underway, complementing financial sector reform, in an effort to make Cuba more attractive for investors. Furthermore, for the first time, Cuba reported its foreign currency holdings – previously a state secret. This reporting is a step forward in establishing the full convertibility of Cuba’s currency, which currently cannot be exchanged for other currencies outside of Cuba.

The Future

Cuba’s reforms are the foundation for eventually developing a dynamic economy and financial sector, comprising both Cuban and international participants. Cuba’s reforms are benefiting its citizens and businesses, and also the international companies and banks already operating on the island. Whether or not the U.S. lifts its sanctions, Cuba is on its way to a mixed economy, perhaps one that won’t be so different to that of China’s, with elements of Communism complemented by elements of a free market. Cuba should closely monitor the current downturn in the Chinese economy, financial markets and currency challenges to avoid these as they embark on a similar period of economic and financial growth.

While the “thawing” in relations between the U.S. and Cuba undoubtedly reflects a positive move towards integration and cooperation, these policy changes should not be viewed as the central reason for Cuba’s recent developments. Especially so, given many of the sanctions are still in place. Cuba’s transition is underway with or without the U.S., as their own reforms have opened the doors to the rest of the financial world. This transition will require substantial infrastructure investment within Cuba to support and process the new volume of financial transactions to the new regulatory standards that the G20 have introduced over the last 5 years. Equally infrastructure changes will be required across the broader global financial markets to integrate and connect to Cuba’s financial markets. Cuban and global financial institutions should work together to build out this infrastructure, sharing their experience and lessons learned throughout the period Cuba was in isolation.