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25 February 2006


OFFICE OF THE SPECIAL ENVOY
FOR DISENGAGEMENT

25 February 2006

Dear Colleagues,

Following our telephone conference on Monday and further to my note from yesterday I am providing, as requested, an update on the PA's financial situation.

Unless a solution is found, we may be facing the financial collapse of the PA within two weeks. And the first target is even sooner – I am advised by the Acting PA Minister of Finance that he requires $60-80 million next week to begin to pay wages. I know I do not need to tell each of you that the failure to pay salaries may have wide-ranging consequences - not only for the Palestinian economy but also for security and stability for both the Palestinians and the Israelis. And it comes at a time when Israel prepares for elections.

At your meeting in London on 30 January, we had reason to expect that the financing needs of the transitional PA government could be met if Israel was to continue the transfers and the World Bank would pay out the Trust Fund in full. Even with that expectation, you 'expressed concern over the fiscal situation of the Palestinian Authority and urged measures to facilitate the work of the caretaker government to stabilize public finances'.

In fact the situation has worsened and the PA Ministry of Finance now faces a budget deficit of at least US$ 260 million over the expected remaining lifespan of the caretaker government (February and March) mainly because of Israel’s decision to withhold tax and customs revenue transfers of up to US$ 130 million. To date the PA has identified funding for this period of roughly US$ 90-150 million leaving a financing gap of US$ 110-170 million.

At the same time, the US has requested the PA return an earlier contribution of US$ 50 million for infrastructure projects. This and the PA's obligation to service outstanding loans may increase the budget deficit in February and March to US$ 370 million.

It can be said that we are in the midst of directly undermining the policy set by you on 30 January which I had understood was set to avoid the collapse of the PA and to allow us all to work together to find a way through this crisis. Without a better effort, public finances will not be stabilised and there will be no alternative but deterioration in the overall situation – which, is something I hope we all wish to avoid. We can do better – even with the constraints under which we are all operating.

As indicated in the attached table (Annex A), the PA's monthly expenditures amount to US$ 165 million. The PA's income in February is expected to be US$ 35 million in domestic tax revenues – less if banks withhold funds owed to them. Following my recent visit to the Gulf, Saudi Arabia has now confirmed that a contribution of US$ 20 million will be made in February. Norway and Russia are in the process of finalising the modalities and timing of a contribution of US$ 10 million each.

The European Commission continues to be generous in its support to the Palestinian people, up to a total of US$ 138 million. This includes US$ 76 million for UNRWA. The EC has reacted promptly to the unfolding crisis situation and is offering an interim emergency relief contribution of US$ 48 million which will be used to pay different Palestinian and Israeli utility companies. The EC is also prepared to support payment from the World Bank Trust Fund of a contribution by them of up to US$ 24 million.

The current discussion among contributors to the World Bank Trust Fund will lead to a disbursement of up to US$ 60 million in March. A decision regarding the amount and timeframe of the payments is expect early this week, although it may be that only US$ 30 million will be disbursed due to the PA’s failure to reach the required benchmarks. Donors are currently debating whether or not to pay out fully. The final amount will be extremely important and a decision should be made quickly to get preparations underway for an actual payment.

So to repeat, our very immediate concern is the financing gap in February and March:

i) GoI may wish to consider ways in which it maintains its decision not to support Hamas but find an alternative route to pay the clearance revenues, for example assist the Palestinian people to pay fuel bills owed to the Israeli private sector; this could free roughly $60 million monthly to be collected from petrol stations;
ii) the Arab countries must continue to support the PA with additional funds in the interest of general Middle East stability, given the current level of oil revenues; we should seek to engage them in a truly international effort - it cannot be that the burden of support falls on only a few donors; and
iii) The Word Bank Trust Fund must consider carefully how much it can release for the next salary payments. The short-term issues are clearly dominant. However, assuming that we are able to see our way through to overcoming the immediate crisis in this way, we must also be aware that in the absence of a cohesive strategy to address longer-term development needs of the Palestinian people, all efforts to promote institution-building and self-sufficiency will come to a stand-still. The Palestinian economy will be starved of finances that are normally channelled by way of PA salaries and capital investment. This loss will likely be compounded by a reduction in the number of labourers working in Israel and in the movement of goods which in turn will lead to a further deterioration in an already embattled economy and lead to a further drop in domestic revenues. This can only lead to greater discontent.

Suggestions I have heard in recent days indicate a high degree of uncertainty in the donor community and there are many questions on how to deal with the new reality. Some ideas aim at routing aid away from the PA to NGOs and humanitarian organisations, not dissimilar to the situation prior to 1994. Dependency in foreign aid for humanitarian purposes will sharply increase while at the same time unemployment figures and poverty rates will deteriorate and any development progress made will come undone: Others suggest the creation of new structures parallel to the PA or at least structures through which salaries could be paid - which would again unravel all our capacity building efforts of the past ten years and will only result in a disjointed development effort.

I would plead for a careful examination of all these ideas against the long-term development goals we are pursuing. The failure to provide coordinated leadership will lead to hasty decisions, jeopardizing many years of a democratisation process and institution building and lead to the situation where there truly can be no partner for peace. It is clear to me that the international donor community, especially on the ground, is looking for guidance and leadership in the coming months. If we do not want to see rising tension leading to violence and chaos - particularly just before the Israeli election - we will have to develop urgently a convincing strategy addressing the PA's financial and developmental needs not only in the short-term of the next few weeks but also in a longer time frame. This includes addressing in a constructive way the issues of tax and customs revenues withheld by Israel. It cannot be in Israel's interest to have a sharp deterioration of the economic and humanitarian situation next door.

In the immediate future, I suggest a small meeting be called of key donors and the United Nations at the appropriate level during the second week of March to discuss mechanisms which we can all countenance without violating any of our own laws and policies which would, at the same time, ensure the government structure we have all helped the Palestinians develop over these years is maintained and avoid the chaos that is likely to ensue if we do not adopt a common and effective strategy in the near future.

If we don't get this right, I am afraid past investment in the Palestinian development will be lost, a Palestinian economy will not be sustainable, the Palestinian people will live off humanitarian hand-outs, and security for both Palestinians and Israelis will be in greater jeopardy than it has been for years.

Yours sincerely,


James D. Wolfensohn
Special Envoy for Disengagement

Kofi Annan
United Nations Secretary General
New York, New York
USA

Sergei Lavrov
Foreign Minister of the Russian Federation
Moscow, Russia

Condoleeza Rice
United States Secretary of State
Washington, D.C.
USA

Ursula Plassnik
Federal Minister for Foreign Affairs
President of the EU Council of Ministers
Vienna, Austria

Benita Ferrero-Waldner
Member of the European Commission
Brussels, Belgium

Javier Solana
High Representative of the European Union
Brussels, Belgium


ANNEX A

PA Financing needs in February and March 2006
24 February 2006

In the absence of clearance revenues from Israel, the PA faces a minimum monthly recurrent budget deficit of $130 million. The PA must raise at least $260 million in financing for February and March. The deficit may widen to $360 million due to the United States' requested return of $50 million previously provided for infrastructure development projects, and due to required repayment of as much as $50 million in bank lending and arrears to key private sector suppliers. At the time of writing there was still uncertainty regarding possibilities for bank lending and further use of PIF as a source of financing. Identified funding for the months of February and March ranges from $90-148 million.

In US $ million
February
March
Revenues
up to 35
up to 35
Domestic revenues 1
up to 35 up to 35
Revenue transfers from GOI 2
0 0
Expenditures and Net Lending
165
165
Wage bill and unemployment benefits
115115
Non-wage expenditure 3
30 30
Net lending (fuel payments and subsidies)
20 20
Recurrent Budget Deficit
130130
Anticipated External Financing
30
60-118
European Commission 4
20-48
World Bank Reform Trust Fund 5
30-60
Norway 6
10
Russia 6
10
Saudi Arabia 7
20
FINANCING GAP*
100 12-70
Note: Qatari transfer of $14 million omitted here as it went directly to repay lending secured in January against these funds.
* may widen by US$ 100 million (repayments to US and banks)

1 Domestic revenues are expected to equal the monthly 2005 average of $35 million assuming no funds are withheld by commercial banks for repayment of lending. The Ministry of Finance (MOF) has stated that domestic revenues may also be reduced in February by as much as $10 million due to processing of higher than usual VAT refunds.

2 GOI monthly revenue transfers in 2005 averaged $65 million. Estimated recurrent budget deficit presented here assumes continued monthly payment of some $10 million to GOI for utilities (electricity and water) out of the withheld revenues.

3 Non-wage expenditure includes basic operating costs and transfers such as retirement payments and pension contributions. The MOF emphasizes that they are not able to further reduce non-wage expenditures.

4 The amount and timing of a transfer from the European Commission remains to be decided. While €40 million will be made available, it is expected that the funds can be applied to costs of public fuel consumption owed by the Gaza Electricity Company to Israeli private sector companies and other utilities. Public fuel consumption costs are roughly $10-15 million per month while utility payments will continue to be covered by revenue withheld by the GOI. The transfer would thus effectively free up at least $20 million that can be used toward payment of salaries. Depending on the type of payments the impact on the budget may be bigger.

5 No decision has been taken yet regarding the release of the $60 million held by the World Bank Reform Trust Fund. The Bank recommended a release of the full tranche and continues to consult with the donors about the amount and timing of disbursements.

6 Norway and Russia will each provide $10 million although the exact timing and mechanism of transfer (i.e. direct or via World Bank Trust Fund) has not been decided.

7 In light of recent communications between the Saudi Foreign Minister and President Abbas, the MOF is optimistic that $20 million promised by Saudi Arabia will be transferred before the end of February.

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