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Source: International Monetary Fund (IMF)
24 September 2007






MACROECONOMIC AND FISCAL DEVELOPMENTS
IN THE WEST BANK AND GAZA


AD HOC LIAISON COMMITTEE MEETING
NEW YORK, SEPTEMBER 24, 2007

INTERNATIONAL MONETARY FUND



I. RECENT ECONOMIC DEVELOPMENTS

1.
The Palestinian economy entered a very difficult phase following the formation of the Hamas-led government in early-2006. Economic activity was curtailed by the intensified restrictions on movement and access, particularly across Gaza’s borders. The situation was exacerbated by the destruction of physical nfrastructure during the Israeli incursion into Gaza, the limited financing for government spending as a result of financial sanctions, and increased uncertainty about the Palestinian territories’ prospects. Gross Domestic Product is estimated to have fallen by 5 to 10 percent in real terms in 2006, leaving average real GDP per capita almost 40 percent below its 1999 level. By comparison, real per capita GDP in Israel rose by almost 10 percent over the same period. Indicators of the labor market, trade with Israel, deposits with banks, and indirect tax revenues suggest that the pace of economic decline may have eased during the first half of 2007. However, the tightening of trade restrictions on Gaza since the Hamas takeover in June 2007 is likely to have further reduced economic activity in that area in the second half.

2.
The decline in economic activity has been particularly pronounced in Gaza, which has been subject to greater instability and tighter closures by Israel than the West Bank. The unemployment rate was estimated at about 35 percent in Gaza and 20 percent in the West Bank in 2006. Poverty levels have been increasing, with some surveys indicating that about two-thirds of households in the West Bank and Gaza (WBG) were below the poverty line at end-2006.1 The World Food Programme and the Food and Agriculture Organization have warned that rising unemployment and poverty are posing acute challenges to food security. The economic and humanitarian situation in Gaza has deteriorated markedly since the Hamas takeover, with the closure of the primary border crossings with Israel and the consequent drawdown of stocks of basic commodities.
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1 According to the July 2007 report by the United Nations Development Programme (UNDP), a majority of Palestinians, about 58 percent, live below the poverty line, and about half of them (30 percent of the population) live in extreme poverty. A majority of Palestinians (about 60 percent) reported a decline in their household incomes in 2006–07.

3.
Unemployment remains high, but has declined slightly due to temporary factors. According to the Palestinian Central Bureau of Statistics (PCBS), employment in WBG increased by 4 percent (31,000 workers) between the last quarter of 2006 and the second quarter of 2007, reaching a total of 749,000 workers. Almost all of this increase was concentrated in Gaza, largely reflecting temporary employment generation programs by UNRWA and increased Palestinian Authority (PA) employment. As a result, the overall unemployment rate stood at 19 percent in the second quarter of 2007 (16 percent in the West Bank and 26 percent in Gaza), down from 24 on average in 2006. By comparison, unemployment was just under 12 percent in 1999, before the start of the second Intifada.

4.
Inflation remains low, at about 1 percent in the year to July 2007. Price increases in WBG largely mirror inflation developments in Israel, and have been dampened by the appreciation of the New Israeli Shekel (NIS) in 2006. While inflation has been tempered by the decline in Palestinian consumers’ income, particularly in Gaza, prices continue to be buoyed by high transport costs due to restrictions on the movement of goods.

5.
Despite the difficult economic environment, banking sector deposits continued to grow, increasing by about 11 percent in the year to June 2007. This reflected both continued growth in banking intermediation (the number of bank branches has increased by about 15 percent since end-2005) as well as strong inflows from the Palestinian diaspora. This has raised the deposits-to-GDP ratio to over 90 percent, which is high by regional standards. However, after expanding by about 8 percent in 2006, credit to the private sector remained stable during the first half of 2007, leaving the ratio of loans to deposits at a relatively low level. Banks were able to reduce their large exposure to the PA and its employees by liquidating collateralized assets and making regular deductions from salary payments.2 Liquidity in the banking sector remains at about 75 percent in June 2007. Paid-up capital of banks has increased since 2005 by 75 percent, to about 8 percent of total bank assets. These indicators suggest that overall the banking sector is in a reasonably solid position to face potential borrowers’ difficulties.
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2 The share of loans to the PA and its employees in total loans is estimated to have declined from above 45 percent in March 2006 to below 40 percent in June 2007.

6.
The Palestinian Monetary Authority (PMA) has persevered in the implementation of strict prudential and regulatory standards in line with international practice. It has worked closely with the Bank of Israel to ensure continued smooth relations between Israeli banks and those in the West Bank and Gaza in a difficult political environment. A new Anti-Money Laundering (AML) law was adopted by the PA government in August 2007, and will start being enforced in the coming weeks. New banking and PMA laws are in the final stage of preparation. Considerable progress continues to be made on internal reform and capacity building at the PMA with technical assistance from the IMF, the World Bank, and other TA providers.

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