Moody's Changes Cuba's Outlook To "Stable" From "Positive"; Caa2 Rating Affirmed

Rating Action:

Moody's changes Cuba's outlook to stable from positive; Caa2 rating affirmed

Global Credit Research - 08 Nov 2017

New York, November 08, 2017 -- Moody's Investors Service has today affirmed Government of Cuba's Caa2 foreign currency issuer rating, assigned a Caa2 local currency issuer rating, and changed the rating outlook to stable from positive.

The key drivers of the change of outlook are:

1) The rapprochement process with the United States has stalled resulting in a reversal of measures to ease the economic embargo, and in recent months US-Cuba relations have deteriorated

2) Moody's expectations of continued reform momentum and favorable macroeconomic performance have not materialized due to a series of climate shocks, strained relations with the US and the upcoming domestic political transition

Cuba's Caa2 sovereign rating reflects credit weaknesses that include limited access to external financing, structural inefficiencies, political transition risk, and importantly, limited data transparency. The rating also incorporates the economic impact of the growing tourism sector, nickel-related mining activities, and the potential for future economic diversification.

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).

RATINGS RATIONALE

RATIONALE FOR THE OUTLOOK CHANGE TO STABLE

The positive outlook on Cuba's Caa2 rating was based on increased prospects for rapprochment with the US as well as for domestic economic reforms. The principal drivers of Moody's decision to change the outlook to stable from positive are the stalled process of rapprochement with the US, and the dimmer prospects for further economic reform on the island.

Restrictions on travel to Cuba, which the previous US administration had loosened, have been tightened. Regulations effective 9 November rescind the travel authorization for individual "people-to-people" exchanges, a broad category increasingly used by Americans under the previous administration to conduct legally authorized travel to the island without the need to participate in organized group exchanges. The tightened controls also include a provision applicable to persons that are otherwise authorized to engage in Cuban travel or other Cuba-related activity, prohibiting them from engaging in most direct financial transactions with 180 entities linked to the Cuban military, which controls a broad swath of the tourist economy.

While the tightened travel authorizations only reinforce the longstanding statutory tourism ban on Cuba, these changes and new sanctions targeting the Cuban military highlight a reversal of the previous rapprochement efforts undertaken by Cuba and the previous US administration. Although a number of relevant measures taken by the previous US administration remain in place, Moody's believes that the changes to be adopted on 9 November will curtail the flow of American visitors to Cuba and diminish impetus for investment into the country, primarily into tourism projects, but also into other sectors that were expecting a further opening up of the Cuban economy.

More recently, diplomatic relations between the US and Cuba have become strained by alleged sonic attacks on US embassy and government personnel in Havana, resulting in the US recalling the majority of the staff from its embassy in Cuba and expelling Cuban diplomats from Washington. These developments will likely constrain further economic or diplomatic openness between the two nations.

Despite recent growth in the tourism sector, Cuba's economic outlook remains challenging following climate and commodity price shocks, and negative spillovers from the economic crisis in Venezuela. The country has been hit by two major hurricanes since late-2016. This caused widespread destruction and affected economic activity. Agriculture, food production, construction and healthcare likely posted a significant contraction owing to the various shocks faced by the economy. Key export prices for nickel have recovered but remain short of the highs achieved in 2008 and 2011, and sugar prices remain near 2015 lows.

Moody's estimates that the Cuban economy contracted 0.9% in 2016 despite a 13.3% increase in visitor arrivals. Moody's forecasts that the economy will contract once again in 2017 by 0.5% before returning to moderate growth of 1.1% in 2018. Nevertheless, prospects for recovery remain fragile and the upcoming political transition will limit the pace of reforms that could support economic recovery.

President Raul Castro will step down at the end of his second five year term in February 2018. This will be the first time since 1959 that a member of the Castro family will not rule Cuba, potentially posing risks to political stability and increasing uncertainty over economic policy and prospects. Moody's believes that risks to economic liberalization are substantial given the state's wavering commitment to private enterprise and Cuba's lack of experience with implementation of market policies.

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 or domestic reforms that have a material impact on Cuba's economic prospects. 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, evidence of increased stress on Cuba's external finances along with deteriorating economic prospects due to external shocks or reform reversal would result in downward pressure on Cuba's rating.

GDP per capita (PPP basis, US$): $7,700 (2016 Actual) (also known as Per Capita Income)

Real GDP growth (% change): -0.9% (2016 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 3.1% (2016 Actual)

Gen. Gov. Financial Balance/GDP: -6.8% (2016 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 0.7% (2016 Actual) (also known as External Balance)

External debt/GDP: 23.4% (2016 Actual)

Level of economic development: Low level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

Note: Numbers have been updated to 2016 (from 2014), which is what was used for committee purposes.

On 06 November 2017, 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 decreased. The issuer's institutional strength/ framework, have not materially changed. The issuer's governance and/or management, have not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. Please see the Rating Methodologies 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 credit rating action, if applicable.