West Bank and Gaza macroeconomic and fiscal framework: Second review of progress – IMF report for AHLC

MACROECONOMIC AND FISCAL FRAMEWORK

FOR THE WEST BANK AND GAZA:

SECOND REVIEW OF PROGRESS¹

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

New York, September 22, 2008

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¹ This report was prepared by a team comprising Oussama Kanaan, Henry Ma, Joël Toujas-Bernaté, and Roman Zytek. The macroeconomic and fiscal framework set out in the Palestinian Reform and Development Plan (PRDP) was assessed by IMF staff in “Medium-Term Macroeconomic and Fiscal Framework for the West Bank and Gaza,” which was issued on December 5, 2007. The first review of progress in implementing the framework was issued on May 2, 2008. Both documents were published on the IMF website (www.imf.org/wbg).

EXECUTIVE SUMMARY

The economic and political environment in the West Bank and Gaza has been less favorable than hoped for in the Palestinian Reform and Development Plan (PRDP). The Government of Israel (GoI) has tightened restrictions on movement and access in the West Bank based on security concerns, and Gaza remains isolated, dampening private sector growth. A surge in inflation has further eroded household incomes and raised production costs. Other external factors have also had an adverse impact, including the slowdown in the Israeli economy and the sharp appreciation of the shekel vis-à-vis the dollar. These constraints have offset other positive developments, including significant flows of external budgetary assistance, as well as improved confidence following the deployment of Palestinian security forces in major cities of the West Bank.

Despite the difficult conditions on the ground, the PA has continued with prudent fiscal policies and reforms. A strict government employment policy has been followed, wage rates have been virtually frozen, and a range of measures have been implemented to improve utility bills payment. The Public Financial Management System has been strengthened further, which is helping prioritize and raise the quality of spending. Reflecting higher inflation, some expenditures in the first half of 2008 were higher than anticipated in the budget, and wage arrears were repaid at a faster pace, which helped cushion the erosion of employees’ real incomes. Nevertheless, expenditure increases have been below the inflation rate, implying a retrenchment in real terms. The recurrent fiscal deficit (on a commitment basis and excluding one-off revenue items) is projected to decline from 27 percent of GDP in 2007 to about 23 percent in 2008. The 2009 budget currently under preparation envisages continuation of PRDP reforms, which would reduce the deficit further to about 17 percent of GDP.

Donor assistance for the recurrent budget disbursed or identified so far is much higher than pledged at the December 2007 donors’ conference in Paris, but still falls short of the amount needed to finance the cash deficit for the whole of 2008. External financing requirements for 2008 are projected at $1.85 billion, of which $1.2 billion was disbursed during January to August. This leaves about $650 million needed in the remainder of the year, of which about $330 million has been identified. In 2009, external financing requirements are projected to decline to $1.3 billion, reflecting a reduced deficit and lower repayment of arrears. However, so far only about one third of that amount has been pledged.

Close cooperation among all three parties, the PA, the GoI, and donors, remains critical to the success of reforms and the recovery of the Palestinians’ living standards. A collaborative approach has become all the more important given the increasingly difficult global economic conditions, which compound the impact of restrictions on domestic inflation and growth. Perseverance by the PA in the PRDP’s implementation is essential for fiscal sustainability. However, there is a risk that its efforts will be hampered by social and political pressures, especially if incomes and employment opportunities remain constrained. That risk would be substantially reduced through a relaxation of Israeli restrictions, a further improvement in the security situation, and the timely disbursement of adequate donor assistance.

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