Particularly worrying are prospects of foreign companies abandoning investment projects to develop Cuba’s natural resources, as global prices for nickel, iron ore and sugar continue to slide. According to figures published by the Cuban authorities in late December, the Cuban economy expanded at a clip of 4.3% in 2008, about half of what the economy ministry originally projected. The National Statistics Office’s methodology for calculating GDP growth includes public services in addition to economic activity, thus exaggerating the actual growth rate. Indeed, I imagine that this could add some three-to-four percentage points to real GDP growth, implying that economic growth, going by the official figures, has remained barely positive in 2008.

While Cuba’s Economy Minister José Luis Rodríguez sees 2008 as ‘without a doubt one of the most difficult’ years since the collapse of the Soviet Union, Risk Watchdog believes that more economic hardship is in store for the Caribbean island in 2009. Despite prospects for a new chapter in US-Cuban relations with the onset of the Barack Obama administration on January 20, I see no change to trade restrictions on Cuba for the time being. Moreover, while President-elect Obama signalled that he may ease travel restrictions and remittance flows to Cuba, the consumer-led recession in the US will likely keep any benefits of such a move limited, in my view.

A New Mindset
The 50-year anniversary of the revolution seems to have coincided with a change of leadership and a new mindset in the country. Since Raúl Castro took over as president from his brother Fidel in February 2008, many Cubans and outside observers set high hopes for economic and political reforms, which would provide new economic opportunities and greater civil liberties. Although there are hardly any tangible reforms to speak of at this point, Risk Watchdog believes that Raúl Castro has put mechanisms into motion, which will likely brand Fidel’s successor as a reformer in the years to come.

During Raúl Castro’s address to the national assembly on January 1, Cubans may have witnessed the most critical assessment of the country’s economic imbalances and problems since the revolution. The president highlighted the island’s economic challenges, and warned of severe imbalances in public finances, announcing that cost-cutting measures are unavoidable. Although no clear measures have been proposed in response to Castro’s comments, the president suggested that many subsidies and free-of-charge services will be reduced or altogether eliminated. Cuba’s minimum retirement age will be raised from 60 to 65 for men and from 55 to 60 for women in an effort to increase productivity and reduce the financial burden of an ageing population. What is more, the state budget for travels abroad for state officials will be cut by half, and free vacations in state-run hotels used to incentivise high-ranking officials or commendable workers will be abolished, among several other cost-cutting measures needed to tighten the belt.

Some To Become More Equal Than Others?
Raúl Castro has previously signalled that he is willing to break with Cuba’s emphasis on income equality in an effort to boost productivity. Indeed, in a recent speech, the president suggested that equality referred to equal rights and opportunities, as opposed to equal income. A similar tone echoed in his speech on January 1, when he suggested that people are more interested in their salaries, rather than in what they can obtain for free. Notwithstanding the ideological implications of such a policy on the Partido Comunista de Cuba (PCC), less emphasis on state-sponsored services may provide welcome relief for strained government finances.

What will be the implications of this new mindset, and will the PCC now be able to prevent a shift towards market economics? What is more, how will a growing sense of disillusionment with promised reforms by Cuba’s old guard play out, particularly as deep spending cuts will continue to be announced in the months ahead?

Risk Watchdog believes that there are three key factors, which will be vital in determining to what extent Cuba’s political and economic environment can change: Firstly, regarding the domestic political setting, while recognising the fiscal and economic challenges facing Cuba today is a major step, demonstrating political will for far-reaching reforms may prove a considerable challenge, particularly when trying to avoid a sudden change of the political landscape.

Secondly, Risk Watchdog cautions that Cuban relations will unlikely dominate the foreign policy agenda of the new Obama administration. As such, it will be key to see how prospective reforms in Cuba will be perceived by the US and to what extent the US may be willing to provide financial and economic relief to the island.

Finally, on a regional level, players such as Brazil may play a vital role in reform incentives in Cuba, and act as a crucial mediator with the US going forward.

Exchange Rate, GBP/EUR

However, over at www.businessmonitor.com, I have explained how I think it could be time for a reversal in sterling’s fortunes. Not only will 2009 be the eurozone’s turn to experience the pain that the UK felt in 2008 – the full extent of banking sector problems have yet to emerge and the export sector looks set to hit the rocks amid a global slowdown – but sterling has slumped to a quite incredible degree.

Exchange Rate, DEM/GBP (Synthetic)

To illustrate this fact, I have produced a chart which shows the GBP/EUR exchange rate expressed in terms of the old pound-German mark exchange rate (that is one euro is worth DEM1.95583 post-change over). This shows that the pound is now worth less than it was after Black Wednesday when Britain was ejected from the Exchange Rate Mechanism in 1992, and the declines in the year following this ignominious event were much smaller than those over 2008 at ‘just’ 17%.

But why does this matter? After all, the Ruthenians are obscure and few in number (some say up to a million) right? Well, yes, but one of the lessons of the collapse of the USSR and Yugoslavia is that what were once highly obscure places like Kosovo, Macedonia, and Ossetia can quickly become global crises once the Great Powers get involved.

The reason the Ruthenians matter – at least from a geopolitical point of view – is that on declaring independence just before Christmas, the self-styled prime minister, Petr Getsko, called on Russia to recognise the new state, which is tucked away in the bottom left hand corner of Ukraine that borders Poland and Slovakia. It is unclear how much local support the declaration carries, but it may be worth keeping an eye on.

Russia has not said anything thus far, but given that Moscow officially recognised Georgia’s breakaway republics of South Ossetia and Abkhazia a few months ago after going to war with Georgia, there is now a precedent for the Kremlin’s unilateral recognition of new states. Indeed, Russia and Ukraine have been at loggerheads in recent years over gas supplies and the latter country’s drift towards the West under President Viktor Yushchenko following the 2004-05 ‘Orange Revolution’.

Moreover, the coming year will see another presidential election in Ukraine, in which the country’s geopolitical orientation will be tested. Therefore, if Moscow senses that Ukraine is irreversibly on a Westward course, it could stir up trouble by supporting the Ruthenians. However, too much meddling could backfire, for it could embolden Kiev’s anti-Russian mood. Either way, the Ruthenians could be set to enjoy – in the words of their most famous descendant, Andy Warhol – their fifteen minutes of fame.

I will be back on Monday 5 January 2009.

I wish all readers a very merry Christmas and a happy new year!

In a similar fashion, the South African currency has looked increasingly strong on a technical basis over the past two weeks, and I pointed out the potential for a short-term appreciation towards ZAR9.4000/US$. Indeed, the unit has appreciated by 7.3% since December 10 to trade as high as ZAR9.4550/US$ on December 18, before retracing back to ZAR9.7100/US$ during today’s afternoon session. ZAR9.4000/US$ will remain a key resistance level going forward, and a push through it could set up further gains towards ZAR9.0000/US$ over the coming weeks. That said, a renewed rally in the US dollar is likely to remain the main obstacle to further strength in the short term. Furthermore, due to ongoing volatility in international markets and a potential slowing of investment inflows in light of weakening global and domestic growth, the rand’s upside potential will remain limited over the medium term, and I can see it weakening towards ZAR10.6000/US$ by the end of 2009.

In fact the dollar has depreciated against a host of global currencies, not just the euro. The latest leg down over the past two days is of course due to Ben Bernanke’s decision to aggressively lower the Fed Funds rate to a target rate of 0% to 0.25% and to reiterate that he will ‘employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability’. Given the strong desire on the part of Bernanke to reflate at all costs, given the deflationary forces at play and the perilous state of the US economy, it would not be unreasonable to assume that the current market trends are likely to run further. As the Fed continues to buy US debt instruments, the attraction of holding dollars diminishes.

However, despite the Fed’s actions, I do not see policy rates normalising before 2010, given the ongoing recessionary environment in the US. Indeed I have revised down my growth forecast for the US to -2.0% in 2009 and 0.8% in 2010. As a result, I expect a further round of deleveraging in 2009, which will give upside impetus to the dollar as equity market bear trends resume once the current equity bounce has played out.

Exchange Rate – US$/EUR

Then again, is the current euro rally petering out, ahead of any equity market reversal? The short-term relative strength index (RSI) is in extremely overbought territory, and as today’s chart shows, the US$1.4720/EUR area has clearly acted as strong euro resistance, or dollar support. If the market were to close tonight around the current levels - US$1.4450/EUR – then I would expect the dollar to bounce over the coming days, possibly back to the US$1.3600/EUR area. The risk to this view is a move back above US$1.4720/EUR, which would presage a move to the US$1.5000/EUR region.

A comment posted last week asked about my view on sterling. Well, beyond the short-term, I have to remain bearish, given the ever deteriorating macro picture in the UK - retail sales and housing market collapsing, unemployment rampant – and interest rates converging rapidly towards those in the US. Interestingly sterling did not rally against the dollar in the same manner as the euro. In fact, sterling hit new lows against the euro of GBP0.9556/EUR at one point. Yes, that’s right, it’s nearly at parity with the euro. The cost of my skiing holiday just went through the roof! On an RSI basis, the euro is very overbought, though, as with the US$, and I would expect some retracement. Still, against the dollar, the fact that sterling never made a clean push higher is worrying for the UK currency. Any move back through US$1.5200/GBP opens up US$1.4700/GBP. Short-term movements aside, though, the medium-term fundamentals for the UK currency are decidedly poor.

As for the dollar, following further deleveraging in 2009, the currency is at risk of becoming extremely over-valued due to the fiscal loosening currently being enacted. Indeed, with rates at virtually zero, as the global economy stabilises, the dollar could be viewed as a funding currency for more interesting carry opportunities. Let’s face it, things are pretty bad when your benchmark interest rates are now below those of Japan.

I pity Japan’s present economic policymakers. They are the ones who had solid banks and had presided over one of the longest periods of economic growth in Japan’s post-war history. Alas, the global financial system then went into meltdown, and the Nikkei ended up suffering more than so many other stock markets – even though Japan had limited exposure to the US subprime mess.

And if that were not enough, the unwinding of the ‘global carry trade’ ensured that the yen subsequently soared in value even against a strong dollar, which is where we are today. Moreover, the yen is surging at the least convenient time, when Japan is already in recession, along with the developed world, meaning that it cannot export its way out.

Consider this: the yen is up around 20-25% against the dollar this year, and the dollar is up against most currencies. Then consider that the South Korean won, the currency of Japan’s main competitor in areas such as electronic goods, cars, ships, etc., is now down around 50% against the yen since its 10-year high seen in 2007. Even if external consumers were rushing to buy stuff (which they’re not), this shift in the KRW/JPY exchange rate cannot help but hurt Japan.

There is another problem with the strong yen. It could tip Japan back into deflation. Recall that even when Brent crude peaked at US$147.50/bbl in July 2008, Japan’s consumer price inflation rose only to 2.4% y-o-y – far lower than any country on earth. Now, with oil prices down 70% and Japanese consumer confidence at its lowest ebb, I would not be surprised if the country slid back into deflation – although this time it will probably not be alone.

So what can Japanese policymakers do? Alas, probably not much. Finance Minister Shoichi Nakagawa was quoted as saying that Japan would not intervene to weaken the yen, but in any case it’s not clear whether intervention would work.

The Bank of Japan could well cut interest rates on Friday, but they’re already 0.30%. True, it could theoretically halve interest rates forever, or return to zero, but that would be largely a symbolic step at this stage.