Moody's changes Cuba's outlook to positive from stable; Caa2 rating affirmed
Global Credit Research - 10 Dec 2015
New York, December 10, 2015 -- Moody's Investors Service has today affirmed Cuba's Caa2 foreign currency issuer rating and changed the outlook to positive from stable.
The key drivers of today's rating action are the following:
1) Dependence on Venezuela has lessened since 2014, and despite pressure on Cuba's external finances from lower economic and financial support from its main trade partner, risks remain manageable.
2) Continued reform momentum and increased rapprochement with the United States have supported favorable macroeconomic performance and raise the likelihood that US economic sanctions might be eased further.
The positive outlook on Cuba's Caa2 rating reflects Moody's expectation that measures to diversify trade and financial links will contribute to favorable macroeconomic trends and will coincide with continued easing of economic sanctions by the US. The positive outlook also anticipates that the Cuban authorities will maintain the current reform momentum following the Communist Party Congress in April 2016, while managing challenges stemming from weaker external finances.
Cuba's long-term local currency country risk ceilings and the foreign currency bond ceiling remain unchanged at Caa2. The foreign currency bank deposit ceilings is also unchanged at Caa3. The short-term foreign currency bond and deposit ceilings remain at NP (Not Prime). These ceilings reflect a range of undiversifiable risks to which issuers in any jurisdiction are exposed, including economic, legal and political risks. These ceilings act as a cap on ratings that can be assigned to the foreign and local-currency obligations of entities domiciled in the country.
RATIONALE FOR THE OUTLOOK CHANGE
-- FIRST DRIVER: DEPENDENCE ON VENEZUELA HAS LESSENED, AND DESPITE PRESSURE ON EXTERNAL FINANCES FROM LOWER ECONOMIC AND FINANCIAL SUPPORT FROM ITS MAIN TRADE PARTNER, RISKS REMAIN MANAGEABLE --
The principal driver of Moody's decision to change the outlook to positive from stable is that lower Venezuelan support has fostered diversification and, despite some external liquidity pressures, the risks remain manageable. In 2014, Venezuela greatly reduced trade and investment flows to Cuba as economic stress stemming from lower oil prices and social tensions led to increased liquidity pressures for the oil exporting nation. As a result of lower support from its main trade partner and top provider of financial assistance, Cuba's economic growth slowed significantly to 1% from 2.7% in 2013. However, measures to diversify trade and financial links seem to have been successful and have coincided with a gradual easing of economic sanctions by the US. Although they have not fully offset the loss of Venezuelan support, the outlook for stronger inflows remains favorable over the medium term.
Increased tourism activity has improved the economic outlook for the country, but tourism earnings have not fully offset the decrease in Venezuelan financial inflows which has hurt the balance of payments. Since 2009, the government has substantially curtailed imports and cut state payrolls and subsidies in order to maintain an external current account surplus. Despite these challenges, Moody's believes that external liquidity pressures remain manageable as the authorities have adopted measures to ensure balance of payments sustainability since the 2008-09 liquidity crunch and the crisis that followed the dissolution of the Soviet Union. The country's dependence on Venezuela will diminish further as Cuba diversifies its trade and financial relations over the next two-to-three years.
As barriers to investment and financing constraints continue to ease, supported by continued US rapprochement, the authorities will have much greater scope to access finance and ease the current tight external liquidity conditions. Moody's expects an increase in capital inflows is forthcoming. Both government policy and the changing relationship with the US will encourage more inward FDI, as well as official lending, following the restructuring of commercial and bilateral debt in recent years.
-- SECOND DRIVER: CONTINUED REFORM MOMENTUM AND INCREASED RAPPROCHEMENT WITH THE US HAVE SUPPORTED FAVORABLE MACROECONOMIC PERFORMANCE AND RAISE LIKELIHOOD ECONOMIC SANCTIONS MIGHT BE WEAKENED FURTHER --
The second driver of the outlook change is Moody's expectation that the cautious reform momentum will be maintained as the US is likely to continue easing sanctions. The easing of US trade and travel restrictions came at a crucial time for Cuba, helping to offset the accelerating loss of Venezuelan economic assistance. Rapprochement between the US and Cuba has helped increase overall tourism flows by nearly 16% so far this year. This prompted Moody's to revise up its real GDP growth forecast for Cuba to 3.5% (from 2.3%) in 2015 and 3.0% (from 2.9%) in 2016, while the government expects the economy will expand by 4% this year.
The authorities' expectation of a strong rebound in economic activity this year may reflect the anticipated effect of thawing U.S. sanctions. Increasing permissible US participation in the Cuban economy is likely to have a multiplier effect on economic activity, as it could "crowd in" investment by non-US investors in anticipation of increased visitor arrivals to the Caribbean nation. Moreover, the last Communist Party Congress, held in April 2011, focused on the introduction of economic reforms designed to create more efficient markets and drive productivity growth. Moody's believes that the next meeting (to be held in April 2016) is likely to continue this process by expanding private-sector activity, reducing price controls, reforming the tax system, and potentially addressing the issue of the dual currency system.
The public sector payroll has already decreased strongly, media sources suggest that by 2016 there will be one million fewer state employees than in 2009, and further reductions could come after the next Communist Party Congress. This is in line with the government's strategy to continue expanding the private sector, as these workers are likely to be absorbed initially into the tourist sector and then other sectors as investment comes into the country.
Despite a lack of data availability and transparency that Moody's continues to highlight as an important rating constraint, official and publicly available data remain adequate to maintain a rating on the Cuban sovereign.
WHAT COULD MOVE THE RATING UP/DOWN
There could be upward pressure on Cuba's rating if there is a further easing of US economic sanctions that has a material impact on Cuba's economic prospects and reform momentum is maintained. More clarity over the political transition at the end of President Raul Castro's current term would ease concerns over political and social instability. Enhanced data timeliness and transparency would also be credit positive.
Conversely, the positive outlook on Cuba's rating would be changed back to stable if there is no further progress in US rapprochement and reform momentum is lost. Evidence of increased stress on Cuba's external finances would also lead to a stabilization of the outlook.
GDP per capita (PPP basis, US$): Unavailable (also known as Per Capita Income)
Real GDP growth (% change): 1% (2014 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 2.1% (2014 Actual)
Gen. Gov. Financial Balance/GDP: -2.6% (2014 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: 3.9% (2014 Estimate) (also known as External Balance)
External debt/GDP: 14.6 (2014 Estimate)
Level of economic development: Very Low level of economic resilience
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
On 09 December 2015, a rating committee was called to discuss the rating of the Cuba, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially increased. The issuer has become less susceptible to event risks. Other views raised included: The issuer's institutional strength/ framework, have not materially changed. The issuer's governance and/or management, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The systemic risk in which the issuer operates has materially decreased.
The principal methodology used in this rating was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this rating action, if applicable.
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Vice President - Senior Analyst
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
Anne Van Praagh
MD - Sovereign Risk
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007