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

MACROECONOMIC AND FISCAL FRAMEWORK

FOR THE WEST BANK AND GAZA:

FOURTH REVIEW OF PROGRESS¹

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

New York, September 22, 2009

_____________

¹ This report was prepared by a team composed of Oussama Kanaan (Chief of Mission), Rina Bhattacharya, 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,” issued on December 5, 2007 (SM/07/384). The report on the third review of progress in implementing the framework was issued on February 25, 2009 (FO/Dis/09/24). Staff reports on the West Bank and Gaza are published on the IMF website (www.imf.org/wbg).

EXECUTIVE SUMMARY

There is a realistic chance that the downward trend in Palestinians’ living standards can be reversed in the near future, at least in the West Bank, provided that restrictions on movement and access continue to be eased. Security reforms by the Palestinian Authority (PA), including the reestablishment of law and order in major West Bank cities, were complemented by the relaxation of restrictions on movement and access in expanding private sector activity. However, Gaza’s situation remains difficult, despite some easing of Gaza’s blockade. Provided remaining restrictions in the West Bank are lifted in the remainder of the year, real GDP in the West Bank is projected to rise by about 7 percent in 2009, which would represent the first substantial increase in living standards since 2005. However, assuming only a limited easing of its blockade, Gaza’s real GDP per capita would decline further, although at a slower pace than in 2008.

The PA has continued with institution-building and prudent fiscal policies. These policies, along with progress in public expenditure management and good governance, have bolstered private sector confidence. Discipline in containing growth in public sector wage rates and employment has continued, and utility subsidies are being phased out. However, the war in Gaza has imposed a substantial burden on the budget. While total donor aid during January to August 2009 was generous, in line with the original 2009 budget, over half of it was disbursed as late as in July and August. The Gaza war and delays in donor aid has worsened an already difficult liquidity situation and led to substantial government borrowing from commercial banks as well as arrears accumulation in the first half of the year. It is particularly important for the PA to keep budgetary expenditures in line with the 2009 budget target, notably by restraining non-wage spending.

There is a need to secure adequate and timely donor assistance to finance the budget deficit in the remainder of 2009 and 2010. External recurrent financing requirements for September to December 2009 are projected at about $0.4 billion, including emergency spending for Gaza. This amount is in addition to a minimum of $1.1 billion required for public investment and reconstruction in the Palestinian territories for 2009–10. Continuation of fiscal retrenchment, combined with lower projected emergency spending for Gaza, will result in a substantial reduction in the recurrent budget deficit from $1.5 billion in 2009 to $1.2 billion in 2010.

Close cooperation between the three parties, the PA, the government of Israel, and donors, is critical to ensure the success of reforms and a sustained rise in living standards. Perseverance by the PA in the implementation of the Palestinian Reform and Development Plan, supported by adequate and timely donor assistance, is essential to support higher growth and a steady move toward fiscal sustainability. Risks to the economic outlook would be substantially reduced by a breakthrough in the peace process and the lifting of restrictions on trade not only within the Palestinian territories, but also between the territories and Israel. Indeed, especially given the absence of a functioning seaport and airport, the elimination of these restrictions is essential for an expansion in the West Bank and Gaza’s external trade, which in turn is key to a sustained rise in real GDP per capita beyond 2009.