Cuba Ill Prepared for Venezuelan Shock

The passing of Hugo Chavez was widely anticipated in Cuba by top leaders that carefully arranged for the medical treatment of the Venezuelan president in the island.  The special devotion of Chávez for the revolution made his country a great benefactor in the form of oil, investments and financial subsidies.  Estimates by Ernesto Hernández-Catá  (please see “Cuba’s Dependence on Venezuelan Assistance” in this blog) place the assistance at over 20% of GDP for 2008-2010, matching aid flows from the Soviet Union in 1985-1988.  Guarding against the adverse consequences of policy changes by a new administration in Caracas is a top Cuban policy concern.  On-going reforms in Cuba no doubt have this objective in sight. Given the sizable resources in oil, cash and finance flowing to Cuba, a reduction of Venezuelan aid will cause a severe shock for an economy suffering from an acute shortage of foreign exchange to buy essential foodstuffs and industrial supplies and equipment.  Cuba presently imports over 80% of its foodstuffs most of which are paid in cash. Reforms launched by Raul Castro in the last four years are designed to lower pressure on the state budget, boost private output and employment and, by paying attention to farm incentives, raise foodstuff production.  Self-employment in urban areas is now around 8% of the labor force, and an additional 4% may be involved in private production of foodstuffs.  These efforts, however, have failed to lower imports of food, as government-run farms and cooperatives struggle to improve productivity as reported in official statistics.  High international prices of basic imports such as grains, soybeans, poultry and milk means the island struggles to feed the population adequately. Cuba has not published balance of payments statistics since 2008, when the current account recorded an unusually large deficit. Estimates suggest that since then the current account has shifted into surplus. In 2011, exports increased strongly owing to a recovery in the price of nickel, but this was more than offset by a surge in imports. It is too early to guess the outcome for 012, but the price of nickel has declined from its peak in 2011. The structure of the current account remains problematic: Cuba still must count on exports of services to Venezuela and private remittance from Cubans abroad to finance its large imports of food and oil. To compound these problems, Cuba is cut-off from most international finance from private lenders and international agencies.  The island has been on continuous default on international obligations since 1960.  Banks provide only short-term import credits, usually collateralized by Cuban foreign deposits.  The bond market is also closed except for small private issues placed among friendly institutions.  Available finance comes from official credits supplied by few friendly countries, most notably from Venezuela itself which has invested in and financed numerous projects in oil refining, telecommunications, manufacturing and infrastructure.  China is providing modest medium-term credits for industrial equipment.  Brazil official banks are providing construction finance and concessional credits for foodstuffs while Russia reportedly is providing new export credits for aircraft.  Alternative official sources of credit amount to less than 10% of the value of Venezuelan aid, and it is unlikely that these sources will be rapidly expanded beyond their present level. The Cuban government, possibly as a precaution against future external shocks, built-up its international liquidity in banks of the 43 countries that report to the Bank of International Settlements (BIS) to $5.7 billion by mid-2011 but has drawn down on this recently to finance essential imports and likely also used in new trade with China, Brazil, Vietnam and other emerging countries. BIS deposits were down to $2.6 billion as of September 2012 and are now mostly needed to back on-going trade lines.  Thus they will not be readily available to make-up for a fall in Venezuelan aid. As reforms have been ineffective in strengthening Cuba’s agricultural output and external trade and finance, the country is ill prepared to face a reduction of assistance from Venezuela.  This means the leadership could face choices that up to now it has avoided: accelerating economic liberalization and lifting of restrains on private operation of medium-size enterprises and farms, a much greater role for foreign investment and a sharp reduction of distortions on retail and wholesale prices, wages and foreign exchange.  Membership in international financial agencies such as the World Bank, IDB and the IMF would also be desirable and a step in opening up private sources of external finance.