Palestinian economic developments and prospects – World Bank report excerpts

1. Beyond the impacts of the protracted economic downturn since restrictions were imposed after the Second Intifadah, the Palestinian economy faces a more hazardous prospect- a fundamental change in its composition, with GDP increasingly driven by government spending and donor aid, leaving little resources for investment thus further reducing the productive base for a self-sustaining economy. Contributing to the crisis is an expanding labor force and a shrinking private sector, placing further pressure on the public sector to become the primary alternative for jobs.

2. During the fiscal crisis in 2006 and 2007, the Palestinian economy relied on borrowing, remittances and increased aid outside the standard PA channels to sustain both public and private consumption. Investment, however, fell sharply. According to the Palestinian Central Bureau of Statistics (PCBS), household consumption dropped by only 0.6% between 2005 and 2006. However, investment fell to precariously low levels. Public investment in the last two years has nearly ceased as almost all government funds have been used to pay salaries and cover operating costs. The IMF estimates that private investments fell by over 15% between 2005 and 2006 and there is no evidence that it significantly increased in 2007. Gross capital formation by the private sector remains less than 16% in 2007.²

3. The formation of the Caretaker Government in mid-2007, and the resumption of aid have reversed the impacts of the aid boycott in 2006 and 2007, but only partially. Real GDP was negative in the first half of 2007 but began to recover in the West bank during the second half. Because of the situation in Gaza, real GDP growth in 2007 is estimated to be about 0%³, which given the rapidly growing population indicates falling per capita income⁴. Overall per capital income is estimated to be nearly 40% less than its peak in 1999. The contributing effects of the closures and movement restrictions cannot be overestimated. Between 1995 and 2000, the Palestinian economy was growing at an average rate of 6% per year. If that trend had continued after 2000, when restrictions intensified, real GDP may have been more than double its current value to reach over $8 billion.

4. Moreover, economic indicators have not changed considerably, despite the resumption in aid. Unemployment in WB&G stood at nearly 23% in 2007, up from only 10% before the beginning of the Intifadah in 2000.⁵  Unemployment is highest in Gaza, at nearly 33% of the active work force. This rate is likely to become much higher as the layoffs in the industrial sector become permanent. The unemployment rate in the West Bank is approximately 19%. The percentage of Gazans who live in deep poverty⁶ has been steadily increasing, rising from 21.6% in 1998 to nearly 35% in 2006. With the continued economic decline in 2007 and the implementation of even stricter closures on Gaza, the current deep poverty rate is expected to be higher than 2006 levels. These poverty levels reflect actual consumption. If remittances and food aid are excluded and poverty is based only on household income, the poverty rate in Gaza jumps to almost 67%. The increase in poverty in the West Bank is lower, but is still significant.

5. Overall, a large proportion of the private sector in both the West Bank and Gaza continue to report worsening conditions in their operations. In Gaza, the number of businesses reporting worsening conditions in terms of sales, ability to transport goods to markets, and number of layoffs peaked in June 2007 – August 2007 when the imposition of near complete closure of Gaza began. In the West Bank, the percent of businesses reporting increasingly worse conditions actually rose in the 4th quarter of 2007 with 24% reporting increasing difficulties in transporting goods, 40% reporting falling sales, and 9% reporting layoffs in December 2007 (see Figure 1).⁷

Figure 1: Private Sector Perceptions

6. Private sector activity remains constrained and hampered by movement and access restrictions and reduced  consumption due to lower purchasing power. In the West Bank, business owners perceive lower purchasing power due to the economic downturn on the one hand and Israeli closures, restrictions, and military actions on the other as nearly equal contributors to depressed sales (at about 25% of respondents). Unsurprisingly, in the Gaza Strip the vast majority of businesses attribute their depressed sales primarily to Israeli closures, up from about 14% one year ago when the West Bank businesses responded with the same percentage (see Figure 2).

Figure 2: Private Sector Perceptions on Drops in Sales

7. The government’s 2008 budget, approved on March 31st, envisions total spending of $3.338 billion and a financing gap of over U$2 billion that must be filled by external aid. This is in sharp contrast with the surplus budgets that prevailed in 1999 when the economy was growing. The PA has announced a Palestinian Reform and Development Plan (PRDP) to increase revenues reduce expenditures and introduce sector reforms to enhance efficiency. But even with these measures and assuming resumed economic growth, the fiscal gap for recurrent expenditures alone is projected to remain high, at around $1.63 billion in 2008.

8. The current status of the economy is a result of the need for concrete PA reforms, matched with an immediate resolution of the movement and access restrictions related to Israeli security concerns and settlement growth which have fragmented the economy into disconnected cantons. While the PA has moved ahead with its economic reforms, albeit slowly, there has been little progress on relaxing movement and access constraints.  In the West Bank, the number of checkpoints increased from 376 in August 2005 to over 600 by mid-2008. There are currently 149 settlements in the West Bank, including East Jerusalem, and roughly 110 outposts many of which are regarded as illegal by the Israeli Government. Since the 1993 Oslo Accords, the Settlement population has risen 63% to approximately 450,000. Some 38% of the West Bank has been confiscated for current or future settlements, outposts, closed military areas, municipal boundaries and settlement regional jurisdiction. Palestinians without special permits are restricted from important agricultural areas in the Jordan valley and producers are cut off from the East Jerusalem market. The GoI has established five crossing points to transfer commercial goods between Israel and the West Bank. The crossing points use a back-to-back cargo transfer system similar to the one for crossing into Gaza, however the system is unlikely to accommodate the expected volume of traffic. Over 95% of Palestinian trade is undertaken with or through Israel.

Update on the Gaza Strip

9. The continued closure policy on Gaza since the events of June 14th, 2007 has considerably eroded whatever private sector backbone remained in the economy, and in a manner that is progressively more difficult to reverse.⁸ As mentioned earlier, the percentage of Gazans who live in deep poverty has risen to nearly 35% in 2006, and is expected to have increased further in 2007 and 2008. If revised to exclude remittances and food aid, this poverty rate is closer to 67%.

10. Over 53%⁹ of employment in Gaza is private sector-driven, representing more than 100,000 jobs. Recent data on Gaza’s GDP are not readily available, but Gaza contributed $1.3 billion to Palestinian GDP in 2003 (44%), of which the private sector is the main economic driver. The impacts of the closures will become less reversible with time. Most Gazan industries are export-oriented and have purchase and supply contracts with Israeli and other firms. Gazan manufacturers rely almost entirely on imports for their inputs and until recently, about 76% of their furniture products, 90% of their garments and 20% of their food products were exported to Israel, and some to the West Bank.

11. According to business associations in Gaza, the current restrictions have led to the suspension of 96% of Gaza’s industrial operations, including domestic and export-oriented manufacturing and agriculture, and services (see Table 1). They could access neither the inputs for production nor any export markets, transforming Gaza into a consumer economy driven primarily by public sector salaries and humanitarian assistance. During 2007, the furniture and garment sectors lost potential export sales of approximately $17 million and $24 million, respectively. In June 2007, about 6,500 worked in the furniture sector, and 25,000 in the garment sector. As of January 2008, these numbers dropped to 75 and zero, respectively. According to the Palestinian Contractors Union, the number of construction establishments dropped from 120 in January 2007 to almost zero in January 2008. All the construction and development projects, including those for UNDP and UNRWA which are valued at more than $116 million, have been halted to the absence of construction materials. As a result of the closure imposed on Gaza since June 2007, the halted construction projects are estimated at $240 million and 42,000 workers were laid off.¹⁰ The scarcity of construction materials has resulted in a considerable rise in construction materials cost¹¹.

Table 1: Industrial Decline in Gaza¹²

12. The agriculture export sector, with more than 40,000 workers, has been particularly affected as it is entirely dependent on the export market and on the imports of fertilizers, pesticides, packaging materials, and other inputs. To illustrate, as a result of border crossings closure, Gaza’s carnation farmers were able to export only 10 million flowers out of at least 45 million flowers produced which resulted in $6.5 million loss, and thus resorted to selling flowers as animal feed. It is worth mentioning that carnations and strawberries are the two largest agricultural exports from Gaza. Both carnations and strawberries can generate up to $20 million in income ($10 million each). The estimated lost income from strawberry sales during 2007/2008 season is approximately $7 million.^.13

13. The reduction in fuel imports into Gaza has impacted both private sector activities and donor projects. The Israeli policy of reduction of fuel supplies as a response to continued attacks on Israel began on October 28th, 2007. Between January and September 2007, approximately 18 million liters of fuel were imported per month. This dropped by about 25% in November 2007, 14% in December, 20% in January 2008, 38% in February, and 25% in March. In February 2008, gasoline (diesel) dropped by approximately 67% and benzene steeply dropped by about 80%.¹⁴

Notes

¹ Excerpt from World Bank Economic Monitoring Report to the Ad-Hoc Liaison Committee (AHLC) in May, 2008 titled “Implementing the Palestinian Reform and Development Agenda”.

² IMF Report to the AHLC, May, 2008.

³ IMF Report to the AHLC, May 2008. PCBS quarterly statistics suggest that total growth may be slightly higher. However, taking into account population growth rates would lead to the same conclusion regarding the low-to-negative per capita growth rates.

⁴ At the time of this report, no breakdown in this zero GDP growth figure between West Bank and Gaza was available. In view of the collapse in Gaza’s economy since June 2007, it is clear that GDP in the West Bank must have been positive. However, given that the population in the West Bank is almost double that of Gaza, it can be inferred that modest GDP growth in the former was not sufficient to offset the severe contraction in GDP in the latter.

⁵ PCBS Labor Force Studies, 2008.

⁶ Defined as a NIS 1,837, budget for a family of six for food, clothing and housing only.

⁷ Survey on the Perceptions of the Owners/Managers of Industrial Establishments Regarding the Economic Situation, PCBS, various months from 2006 – 2008. Based on a survey of 350 – 500 establishments in the West Bank and Gaza.

⁸ In response to this statement, the Israeli authorities note the need to stress the reasons behind the current closure policy, including the takeover of Gaza by Hamas militants, and the continued attacks on Israeli civilians. According to Israeli COGAT, about 3,500 homemade rockets have been launched from Gaza into Israel. In March alone, an estimated 110 rockets have been launched into Israel.

⁹ Q4 2007 as reported by PCBS Labor Force Press release, March 2008.

¹⁰ According to PCBS, employment in the construction sector dropped by 78% between Q2 and Q4 of 2008.

¹¹ According to the Gaza Business Associations, the closures on Gaza have led to accumulated losses of $500 million. In addition, the banking sector has dropped by 60%.

¹² Original data from Industrial associations in Gaza reported to Paltrade and recent World Bank interviews with Palestinian Federation of Industries (PFI).

¹³ As reported by Gaza Agricultural Associations and Paltrade. PCBS data differs, showing an increase in

¹⁴ Paltrade, Gaza Terminals Movement Monitoring, Semi-annual Report (Oct 2007 – Mar 2008) April 7, 2008.