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Source: International Monetary Fund (IMF)
21 March 2012





RECENT EXPERIENCE AND PROSPECTS OF THE ECONOMY OF THE WEST BANK AND GAZA1

STAFF REPORT PREPARED FOR THE MEETING OF THE AD HOC LIAISON COMMITTEE

Brussels, March 21, 2012






1 This report was prepared by Oussama Kanaan (Chief of Mission), Udo Kock (Resident Representative), Bahrom Shukurov, and Mariusz Sumlinski. Staff reports on the West Bank and Gaza are published on the IMF website (www.imf.org/wbg).



EXECUTIVE SUMMARY


The economy of the West Bank and Gaza (WBG) has entered a difficult phase, with a slowdown in growth and persisting high unemployment in the West Bank. The West Bank’s real GDP growth has slowed to 5.7 percent in 2011 (compared to a yearly average of 9 percent in 2008–10), and unemployment remains unchanged at 17 percent. There is a high risk that growth will dampen further due to fiscal retrenchment, declining aid and consequent severe liquidity difficulties, the global economic slowdown, as well as the lack of easing of restrictions on movement and access since 2011 due to Government of Israel (GoI)’s security concerns. In Gaza, growth continued its sharp recovery, surging by about 20 percent in 2011, underpinned by the lifting of restrictions on consumer goods and inputs on internationally-supervised projects. However, with continued controls on imports of private investment inputs and on exports, Gaza’s growth is likely to wane and unemployment to remain at around 30 percent. The persistence of high unemployment reflects the skewed nature of growth, both sectorally and regionally, with the labor-intensive sectors still constrained by the restrictions, especially on exports.

The Palestinian Authority (PA) has faced severe liquidity difficulties in 2011, leading to the accumulation of substantial domestic payment arrears. Donor aid was substantially less than envisaged to finance the recurrent budget ($0.8 billion compared to the budgeted $1.0 billion) as well as the development budget ($0.2 billion compared to the budgeted $0.5 billion). These shortfalls, in addition to lower-than-expected tax revenue in the context of a slowdown in economic growth, led to the accumulation of $0.5 billion in domestic payment arrears to the private sector and to the public pension fund. There was also an increase in net domestic bank borrowing by about $140 million, raising the stock of government debt to the banking system to a total of $1.1 billion (11 percent of GDP).

The 2012 draft budget continues fiscal consolidation started in 2008, with a further reduction in the recurrent deficit by 3 percentage points of GDP. However, there remains a substantial financing gap, projected at $0.5 billion. There is little scope to cover that gap through further arrears accumulation to the private sector or borrowing from commercial banks, given the existing large stock of debt to businesses and banks. Therefore there is a high risk that the persistence of that gap will result in cuts in essential spending, including wages and social transfers. Concerted efforts are needed by the three parties (PA, GoI, and donors) to cover that gap.

It is important for the PA to implement a plan to cover the financing gap. That plan should be implemented as soon as possible, given that the 2012 aid outlook is highly uncertain even as of March 2012. Given that the wage bill represents half of total recurrent expenditures, controlling its growth should be part of the plan, including limiting the wage bill increase by reducing cost of living adjustment (e.g., to a maximum of 1.5 percent), with no new net hiring. In the non-wage area, it is important to press ahead with measures to strengthen further the commitment controls system to stem arrears accumulation. Development projects should only be implemented if there are matching funds from donors, to prevent the diversion of aid from essential recurrent spending. On the revenue side, it is important to complement the recent income tax increases with the prompt implementation of measures to improve tax administration, notably through enhancing compliance and widening the tax base.

The PA should also continue to build on the solid track record established since 2008 in reforms and institution-building in the public finance and financial areas. As set out in the IMF staff reports for the Ad Hoc Liaison Committee meetings of April and September 2011, IMF staff considers that, given that record, the PA is able to conduct the sound economic policies expected of a future Palestinian state. The PA has also made major strides in raising the quality and transparency of economic and financial statistics, which now compare favorably with those of IMF member countries that maintain high data management and dissemination standards. This has enabled the WBG to meet the requirements of the IMF’s Special Dissemination Standards (SDDS) in January 2012. Looking forward, it is important for the PA to employ its enhanced institutional capacity to press ahead with measures to further raise public sector efficiency and phase out reliance on recurrent aid, notably through comprehensive civil service and pension reforms, further strengthening of the social safety net, and completion of the transfer of electricity distribution from municipalities to commercial companies.

Raising budgetary revenue in a sustainable manner will require the PA and the GoI to work closely together to enhance clearance revenue collection and minimize leakages. Clearance revenue collected by the GoI on behalf of the PA represents about 70 percent of total budgetary revenue, and thus even a small increase in its yield could significantly reduce the financing gap. In this regard, it is important that the agreements reached between the technical teams of the Palestinian and Israeli ministries of finance be promptly approved at the Israeli ministerial level. Practical measures that could be implemented in the spring of 2012 include the assessment of potential clearance revenue owed to the PA on the basis of comprehensive data compiled by the GoI on trade between Israel and the WBG.

It will be very difficult for the PA to cover the 2012 financing gap through austerity alone, without the prompt pledging and disbursement of additional aid. The shortfalls and delays in disbursements are bound to curtail essential spending, even with further adjustment efforts by the PA. They also impose a significant cost on the PA in terms of interest payments and additional premia required by private suppliers of goods and services. Sustained donor aid during 2008–10 supported the successful implementation of the Palestinian Reform and Development Plan presented at the Paris Donors’ Conference in December 2007 and was essential to sustain orderly reforms and fiscal adjustment. The latter in turn enabled the PA to reduce the aid needed to finance the recurrent budget deficit, from $1.8 billion in 2008 to $1.1 billion in 2010. Timely and adequate aid will allow sustained reforms and adjustment which in turn will enable early self-reliance by the PA for its recurrent spending, with donor aid increasingly focused on growth-enhancing development projects.

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