Economic situation in the OPT – World Bank note

The Fourth Meeting of the Consultative Group for the West Bank and Gaza

 

A Background Note on the Economy

for the Meeting of 19-20 November, 1996

 

World Bank

November 6, 1996

 

 

————————————————————————

 

Contents

 

A. Recalling the Projections of January 1996

B. Economic Developments Since January 1996

C. PA Strategy and Performance in 1996

D. The Donor Program in 1996

E. Economic Priorities and External Financing Needs for 1997-8

Attachment I: West Bank and Gaza at a Glance (not attached to web version)

Attachment II: Donor Assistance 1994-98 (not attached to web version)

 

————————————————————————

The West Bank and Gaza Consultative Group

 

A Background Note on the Economy

 

 

 

 

A. Recalling the Projections of January 1996

1. When the donor community met in Paris on January 9, 1996, at the Ministerial Donor Conference on Assistance to the Palestinians, a mood of cautious optimism prevailed. In anticipation of a new and more promising phase of economic development, the World Bank and the UN had co-authored a paper with the Palestinian Authority (the PA) the Government of Israel (GOI) and other donors entitled "Putting Peace to Work–Strategies and Priorities for the Second Phase of the Development Effort in the West Bank and the Gaza Strip" (September 1996). This paper judged that it was now time to shift emphasis away from emergency assistance towards policies, institutional development and investments which would enhance the Territories' medium-term growth potential–and would do so through a strategy that placed top priority on encouraging private sector participation in reconstruction.

2. The PA/IMF economic estimates presented to the Ministerial Conference forecast a gradual recovery of the Palestinian economy. After declining by some 10% between late 1993 and late 1995 (see Attachment I), real GNP growth was now projected at 6% (i.e. about 1-2% per capita) for 1996. Private investment was expected to increase from 12.7% of GDP in 1995 to 13.7%, and public investment from 4% to 7.5% of GDP. On the basis of encouraging PA revenue performance in 1995 as well as the relatively smooth operation of the revenue clearance mechanism with Israel, a possible elimination of the recurrent budget deficit was foreseen by the end of the year.

3. In response to these developments and to requests by the PA to finance a Core Investment Program of some $550 million, donors pledged $865 million at the Paris Conference to fund investments in 1996. In addition, donors pledged $72 million against the projected $75 million 1996 recurrent budget deficit, with some hope that no further budget support would be needed thereafter.

 

 

B. Economic Developments Since January 1996

4. Unfortunately, these predictions have not materialized, and the final outcome for 1996 is likely to be much worse than once expected. To appreciate the main reason for this, it is important to recall the degree to which the Palestinian economy is dependent on Israel–and thereby on the quality of the political relationship between Israel and the Territories.

5. In September 1993, about 85,000 Palestinians, or about one quarter of the workforce, were employed in Israel, while trade with Israel represented over 70% of exports from and 90% of imports into the West Bank and Gaza. This intertwining of the two economies leaves the Palestinians vulnerable to any dislocation in economic relations; it has led to a compression of economic activity whenever GOI has restricted the entry of Palestinian workers or halted/slowed trade flows on security grounds.[1] These closures, and the uncertainties associated with them, have reduced employment opportunities, interrupted trade and inhibited private investment. Employment of Palestinians in Israel declined to an average of 29,500 for 1995 as a whole, and may not exceed 25,000 (5% of the workforce) in 1996; in parallel, workers' remittances as a share of GDP fell from 25% in 1992 to only 8% in 1995. Internal job creation has not matched this decline, even with the addition of some 36,000 employees to the public sector by the end of 1995 (this figure includes security personnel), and the employment of up to 35,000 laborers at peak periods under various donor-financed construction projects and through the Emergency Employment Generation Program (see paras. 11 & 12);[2] domestic private sector employment grew only marginally through the end of 1995, with increases in agriculture and construction offset by a decline in industry. As a result of these factors, unemployment increased from about 11% of the labor force in 1993 to over 20% for 1995 as a whole. Trade declined after 1993; merchandise exports almost halved between 1992 and 1995 (from 11% to 6% of GDP) while imports also suffered, slipping from 46% of GDP in 1992 to 38% of GDP in 1995. Investment also fell short of expectations. In 1993, public investment amounted to about $125 million, or 4.5% of GDP; in 1995, despite the enormous priority accorded to the reconstruction of the West Bank and Gaza, public investment totaled only $215 million for the year–still just 5.6% of GDP, and all financed by the donors (comparable figures for Egypt and Jordan that year were about 7% in each case).[3] An added complication, though, has been the pressure on donors to divert potential investment funding into support for the Palestinian budget (by September 1996, donors had provided $505 million, or 42% of their total disbursements, for transitional or recurrent expenditures–mainly for the salaries of the civil service and the police; while undoubtedly justified as a transitional provision, this meant the sacrifice of over 20% of the 1994-8 pool of pure grant investment pledges, with more still required). Ultimately more worrying, though, was the steep fall in private investment–from $750 million (or 26% of GDP) in 1993, to $435 million (a mere 13% of GDP) in 1995. Up to 90% of this investment, moreover, continued to reflect the use of personal savings for housing construction. There was virtually no corporate response to Palestinian self-rule in 1994 and 1995, in spite of large potential investments contemplated by Palestinian companies such as PADICO.

6. Conversely, the economy showed signs of resilience and vigor in periods of relative political tranquillity. In the latter part of 1995 and the early weeks of 1996 the decline in economic activity was reversed, resulting in real GDP growth of about 3.5% for 1995 as a whole (though with a population growth rate of over 5-6% in 1995, GNP growth per capita was still negative). Non-agricultural output expanded in the latter part of the year, on the basis of improved public implementation and a boom in private housing construction; overall employment increased by 9% during the year. The Palestinian fiscal position also improved dramatically in the latter part of 1995. This can be attributed to good performance by the PA and by GOI; for its part, the PA managed to contain recurrent expenditure and to improve the efficiency of tax collection, while GOI generally ensured the smooth delivery of tax "clearances", as agreed with the PLO in the 1994 Protocol on Economic Relations[4] (despite some problems with the clearance of customs receipts); as a result, the actual deficit–$108 million–was much less than projected earlier by the IMF. For their part, donors pledged and delivered more than enough to finance the external gap, mainly through the World Bank-administered Holst Fund.

7. As a consequence of the severe border closures that followed the February-March bombings of civilians in Israel, up to 55,000 permit-holding Palestinian workers lost their jobs overnight. In addition, as a consequence of the interruption of merchandise trade and the sudden shortage of materials, another 80,000 jobs were temporarily lost within the West Bank and Gaza by mid-March 1996. Unemployment and severe underemployment[5] soared to two-thirds of the workforce in April–an unprecedented figure. For several days in March, there were shortages of basic foodstuffs in Gaza. Millions of dollars in agricultural exports were lost, and an important share of agricultural production rotted away, compromising the capacity of many farmers to replant for the next crop cycle.

8. From May onwards, economic conditions moderated somewhat. By mid-September, the closure had been relaxed, and imports had returned to pre-February quantities. Exports were still depressed, though (at perhaps three-quarters of the levels of late 1995), while border security measures have raised the cost of merchandise trade relative to the pre-February period. Immediately following the September tunnel crisis, another brief "airtight" closure was imposed, and since October 21 a further precautionary closure has been in force (though GOI has just announced that it will once again issue 35,000 permits). As a result of this year's turmoil, the economic outlook for 1996 is quite bleak. The PA/IMF macroeconomic projections of June 26, 1996[6] still provide a useful guide to the potential outcome for the year. These projections assumed that an average of 25,000 Palestinians would be employed in Israel from July 1 onwards, and that trade would gradually return to pre-closure levels (with imports recovering faster than exports). Under such assumptions, real GNP per capita was expected to decline by 10-12% for the year as a whole, with productive private investment remaining minimal. The PA/IMF fiscal estimates circulated to Consultative Group members earlier this week[7] indicate that Palestinian revenues have held up well in 1996 in spite of the closure. Current estimates indicate a fiscal deficit of $112 million, $50 million of which is unfunded (assuming no increase in PA debt to the local commercial banks). In the wake of the September crisis, however, European donors have so far pledged a further $37.4 million in budget support,[8] and this should avert any immediate fiscal difficulties.

9. Economic developments at the level of the Palestinian household give more cause for concern. The average family has experienced a loss of real income of about a third in the last three years. An estimated one-third of the work-force is currently unemployed, with a further 10-15% severely underemployed. Between mid-1995 and mid-1996, moreover, the labor force grew by 12%.[9] With a traumatized local economy and a contraction of jobs for Palestinians in Israel due to increases in the number of foreign workers, wage rates have been driven down in recent months; between September 1995 and June 1996, real daily wages appear to have fallen by about 22% in the West Bank, and by about 14% in Gaza and for Palestinian workers in Israel.[10] Since the beginning of this year's closure, a reduction in household average monthly cash expenditures of about 14% has been reported, along with a doubling (to 56%) of the number of Gazan households which are now indebted.[11]

 

C. PA Strategy and Performance in 1996

10. A forward-looking Palestinian economic strategy is described in two complementary documents written shortly after the signing of the Interim Agreement–the "Medium Term Policy Framework 1996-8" of November 1995, and "A Preliminary Statement on Palestinian Development Strategy" of December 1995. These papers stress the need for fiscal restraint and re-commit the PA to a private sector-led development path. Economic relations with Israel are assumed to remain governed by the terms of the modified customs union negotiated with GOI in 1994; growth in employment and incomes is expected to come initially from donor-funded infrastructure investments, which would also lay the basis for the emergence of small and medium manufacturing industries, agricultural processing and tourism.

11. In practice, crisis management has dominated this year's economic management agenda. The PA's overriding concern since the March closures has been to try and stem the collapse in employment and incomes, and to provide a social safety net for those families hardest hit by the closure. Measures have included increased transfers (some 20,000 families in the Territories are currently in receipt of PA welfare payments), emergency food imports in the March-April period in coordination with increased World Food Program activity (with WFP distributions in Gaza up by 70% since the beginning of the year's closures), and the inception of the Emergency Employment Generation Program (the EEGP).

12. The PA's performance as an economic manager is improving, albeit under very taxing circumstances. The pervasive atmosphere of economic crisis has detracted from orderly institutional development. Border closures have disrupted the flow of economic inputs and prevented the free movement of PA staff. Despite this, there is appreciable improvement in the capacity of particular PA agencies to implement programs on the ground. PECDAR, in particular, has stepped up its management of the World Bank-financed rehabilitation portfolio,[12] in addition to taking the lead on designing and coordinating the EEGP.[13]

13. At the same time, some worrying trends persist. Formal procedures still lack validity and pronounced rivalries between agencies remain. Procurement decisions at times lack transparency. A penchant on the part of the new sectoral agencies to engage in direct economic activity is at times evident, although this has usually been resisted up to now.[14] One aspect of fiscal management that has begun to concern donors are delays in consolidating all sources of revenue and expenditure under the Ministry of Finance. The PA also needs to reconsider the wisdom of awarding exclusive trading licenses for key imported commodities in the Gaza Strip (eg. petroleum products, cement, tobacco). Relations with NGOs also remain ambiguous and prone to mutual unease. Finally, it will be important to contain the size of the public service, which grew by 30% between October 1994 and October 1995 (including security personnel).[15] While the demands of reconstruction and the service needs of a rapidly-increasing population clearly require some expansion of the civil service, the public sector wage bill is likely to exceed 50% of recurrent expenditure in 1996–a ratio that risks a reduction in operations and maintenance expenditure below advisable minima,[16] particularly in the social sectors.

 

D. The Donor Program in 1996

14. By the end of August 1996, the donor community had pledged $2.9 billion to the Palestinian development program since the signing of the DOP; of this, $2.2 billion had been firmly committed to specific activities, and $1.2 billion disbursed (Attachment II).[17] It is true that donors at first responded slowly to the novel conditions of Palestinian autonomy; on balance, however, the pace of aggregate donor disbursement has improved, as the crude annual disbursement ratio of 18% per annum suggests.[18] Through August, about $505 million, or 42% of donor disbursements, had been provided for "invisible" start-up and recurrent expenditures. Of the remainder, only some $500 million had been disbursed against visible productive investments. Furthermore, the donor program has been active at a time of severe decline in private investment, and of intermittent closure. Taken together, these phenomena more than offset the gains from the donor program.[19] For many ordinary Palestinians, therefore, the benefits of the

donor effort are thus lost against the larger canvas.

15. The donor contribution should not be underestimated, though. Support for the budget deficit, in particular through the Holst Fund, enabled the fledgling administration to survive through 1994 and 1995 without recourse to chaotic lay-offs. Donors have also financed over three-quarters of the productive investment in the Palestinian territories since 1993, and have generated appreciable private employment through the EEGP and other construction activities. The donor coordination fora–the Ad Hoc Liaison Committee (AHLC), the Consultative Group (CG) and their local counterpart committees–have played an important policy guidance role, collectively helping the PA define fiscal and investment priorities, and assisting in the creation of an environment in which the Israelis and Palestinians have cooperated with success in the fiscal sphere. These mechanisms have mobilized funds for targeted purposes, monitored program delivery and helped sustain a high level of public awareness of the assistance program in donor countries.

16. Donor shortcomings remain. These include procedural delays and rigidities, and imperfect operational coordination. In the past two years, a number of donors have taken steps to simplify their own internal approval processes and to delegate decision-making authorities to their field representatives–but the understaffed agencies of the PA continue to be burdened by procedural demands from donors (though there is increasing evidence of the PA's proactive influence on the composition and execution of individual donor programs). Unfortunately, some donor priorities are also still driven to an excessive extent by political and commercial agenda.

17. Overall donor commitments in 1996 amounted to $826 million by the end of August, and disbursements to $287 million–of which some $124 million had been disbursed against start-up and recurrent expenditures, and $163 million against technical assistance and the investment program. Considering the difficulties posed by the closures, this rate of disbursement is quite creditable. Given the general tendency for disbursements to accelerate in the latter part of the calendar year, it appears that the overall 1996 donor disbursement target of $500 million articulated in the revised Tripartite Action Plan signed in Paris on January 1996 can still be achieved.

 

E. Economic Priorities and External Financing Needs for 1997

18. Key PA priorities for 1997, as articulated most recently at the Ad Hoc Liaison Committee meeting of September 5, 1996, include maintaining fiscal stability, a continued emphasis on employment, speeding the delivery of well-targeted public investments as the basis for recovery and medium-term growth, and seeking to build viable institutions of governance.

19. Fiscal stability will require continued improvements in domestic revenue collection coupled with expenditure restraint. While precise estimates have yet to be established for 1997, it is clear from the underlying dynamics of the revenue situation that an absence of closure and access to 50,000 jobs in Israel throughout the year could, if combined with prudent expenditure management, result in the elimination of the structural component of the deficit in the course of 1997. Recent history suggests that this scenario may be optimistic on political/security grounds–and that donors will once again need to set aside a proportion of their 1997 assistance for additional recurrent budget support. This said, it is also likely that some donors will wish to distinguish between a deficit incurred by lax fiscal management–which would not necessarily merit donor support–and a deficit precipitated by emergencies beyond the control of the PA's financial managers. At the September AHLC meetings, the concept of a "reserve fund" was proposed in order to provide for such emergencies–to be administered through a reconfigured Holst Fund. As yet there is no consensus on this question, which will need to be reviewed in light of the 1997 budget and the projected recurrent deficit.

20. Emergency employment programs this year have been funded mainly through the Holst Fund (almost $22 million disbursed since April against EEGP activities) and various UN-assisted projects. Maintaining a program of 10,000 jobs would cost about $6.3 million per month if the numbers employed were to be split evenly between direct hire activities and micro projects.[20] In view of current levels of unemployment, and in order to retain the organizational capacity in PECDAR to gear up to cope with future emergencies, donors may wish to consider financing a program of at least this size. Doing so would require contributions of approximately $75 million for the year through the Holst Fund, the UN or direct bilateral channels. Of this amount, the Bank plans to disburse $10 million: $5 million under ongoing rehabilitation projects, and another $5 million through the proposed Community Development Project.

21. Public investment requirements are described in the PA's submission to the Consultative Group entitled "The Palestinian Public Investment Programme and Funding Needs for 1997". The paper proposes an envelope of $1.28 billion for the year, of which $845 million is needed by way of new commitments. The 1997 program derives from the Public Investment Program presented to the third meeting of the Consultative Group last year.[21] It continues to focus on four main areas–physical infrastructure, the social sectors, support for private sector development and public sector capacity-building. The program's underlying philosophy is consistent with the private sector-led development approach of recent policy documents, and the composition of the program displays an adjustment in favor of private sector support (16% of the unfunded program for 1997, as compared to 6% of the 1996 Core Investment Program).

22. The economic setbacks of 1996 are all the more frustrating in light of the clear growth potential of the Palestinian economy. As many previous reports have indicated,[22] the West Bank and Gaza possesses a number of potential advantages–proximity to the growing Israeli economy, preferential access for Palestinian exports to the markets of Europe and the US, one of the better-educated work-forces in the region, the availability of Palestinian diaspora capital and technology, donor willingness to support the establishment of the Palestinian economy with concessional financing.

23. One of the key challenges facing Palestinian economic managers is to maintain a medium-term policy perspective in the midst of short-term crisis management–and to avoid interventions that compromise the capacity of the private sector to operate efficiently. The Palestinian authorities are well aware of this need for balance and perspective, and have advocated a "two-track approach" to economic development.

24. There is also a need to find ways of moderating the damaging economic and social impact of external shocks to the economy–the most serious of which has been intermittent border closure. The Bank's forthcoming Economic Report, currently under preparation, will aim to provide an analytical basis for a discussion of such questions, and will review relevant aspects of the Palestinian trade policy and external economic relations. Preliminary work completed in preparation for the report will be presented by various contributors at the one-day seminar to be hosted by the Institut Français des Relations Internationales (IFRI) in Paris on November [1] There were 91 days of full border closure in 1993, declining to 71 in 1994 but rising to 125 in 1995.

…

[2] At the height of the Emergency Employment Generation Program, in June 1996, some 26,000 full-time job equivalents were created under sub-projects financed by the Holst Fund (c. 16,000), the World Bank-financed Second Emergency Rehabilitation Project and Municipal Infrastructure Development Project (c. 3,000) and in UN/PECDAR-managed/bilaterally financed projects (c. 6,600). Numbers employed in non-EEGP donor-funded investment projects are harder to estimate, but totaled perhaps 10-12,000 workers. In June, therefore, about 36-38,000 workers, or roughly 10% of those then working, were employed in donor-financed projects.

[3] This stagnation does in part reflect the difficulties involved in setting up viable implementation mechanisms, as well as procedural delays on the part of the donors.

[4] In 1995, over 60% of the PA's revenues came from transfers from the Israeli Treasury. These transfers represent taxes paid by Palestinians but initially accruing to Israel in the form of VAT receipts and customs duties.

[5] Those unemployed are defined as people actively seeking work who did not work a single hour for pay during the survey week; the severely underemployed are those working less than 15 hours per week.

[6] "West Bank and Gaza Strip–Revised Macroeconomic and Fiscal Projections", PA Ministry of Finance/IMF, June 26, 1996.

[7] "West Bank and Gaza Strip–Report on Fiscal Developments in January-September 1996 and Revised Fiscal Projections for October-December 1996", PA Ministry of Finance/IMF, October 21, 1996.

[8] Contributions have been pledged by the European Union ($25 million), and by individual European countries ($12.4 million, all through the Holst Fund–Ireland $0.7 million, Norway $2 million, Sweden $5.3 million, Switzerland $2.4 million and the United Kingdom $2 million).

[9] Data is from the Palestinian Central Bureau of Statistics (PCBS). The total population of the West Bank and Gaza grew by an estimated 145,000 people between mid 1995 and mid-1996 (over 6%). The working age population (15-64) grew by about 70,000, and the proportion of those seeking work grew by 2.2% to 41.2%. The result of this was a growth in the labor force (those seeking employment) from 466,050 to 506,800–12%, or twice the population growth rate.

[10] "Labour Force Survey: Main Findings", PCBS, September-October 1995 and June 1996 rounds.

[11] Reported in "United Nations Special Coordinator's Office, Economic and Social Monitoring Unit, Quarterly Report One" of October 1996. The expenditure figures come from PCBS; the debt information from an independent study.

[12] This comprises the Emergency Rehabilitation Project (1994, $30 million); the Education and Health Rehabilitation Project (1995, $20 million); the Second Emergency Rehabilitation Project (1996, $20 million); and the Municipal Infrastructure Development Project (1996, $40 million).

[13] The EEGP began in April. The largest component was financed through the Holst Fund, and consisted initially of direct-hire clean up activities, with laborers working on 10,18 or 26-day cycles; by June, the Holst Fund and other Bank projects were also financing infrastructure "micro-projects" with higher materials content and greater sustainability. At the same time, the UN, using bilateral financing, supported a variety of small works projects. Between April and August, an average of 18,000 workers were employed. Due to funding constraints, this figure has dropped to about 11,000 by November (approximately 10,000 under the Holst Fund and other Bank programs, and another 700 under UN programs).

[14] In the housing sector, for example, the original concept of a public sector construction program has now been replaced by an approach that emphasizes demand creation through the commercial banking system. In the electricity sector the PA has elected to proceed with private power generation, but is still debating the degree to which the private sector should be involved in the management and ownership of transmission and distribution.

[15] "West Bank and Gaza–Civil Service Study", World Bank, July 1996 (draft).

[16] Though it should be noted that wage payments have remained close to budget. Comparative studies, however, indicate that the wage bill generally consumes closer to 40% of the recurrent budget in neighboring countries; a Bank study of 14 Latin American and African countries, "Civil Service Reform and the World Bank", May 1995, shows that wages rarely exceed 50% of the budget and more often fall well below this.

[17] "Matrix of Donor Assistance to the West Bank and Gaza", Secretariat of the Ad Hoc Liaison Committee, August 1996. This matrix and the figures in this paragraph will be updated at the Consultative Group meeting.

[18] This ratio is derived by analyzing those sums disbursed out of the original October 1993 pledge of $2.2 billion, and assuming a five-year implementation period.

[19] Economic losses from closure have been significant. During the period of "airtight" closure in March and early April, Bank/Fund staff estimated income reductions of $4 million a day from lost job opportunities in Israel alone (direct income losses plus "second round" reductions in income and output occasioned by lower consumption expenditure). Around $150 million in earnings may have been lost in just six weeks using this restricted measure.

[20] 5,000 direct hire (85% labor content) job-equivalents require approximately $1.5 million per month, assuming a daily wage of $10 per day; 5,000 micro-project job equivalents (35% labor content) cost about $4.8 million per month. While micro-projects are clearly preferable from the perspective of direct economic returns, they are less effective as a means of income transfer.

[21] "Public Investment and Associated Financing Needs", PA, July 1995.

[22] See, for example "Developing the Occupied Territories: An Investment in Peace", World Bank, September 1993, and "Prospects for Sustained Development of the Palestinian Economy: Strategies and Policies for Reconstruction and Development", UNCTAD, August 1996. 21.