Fifteeen months – Intifada, Closures & Palestinian Economic Crisis – World Bank assessment (summary, link)

Fifteen Months – Intifada, Closures and Palestinian Economic Crisis

An Assessment

 EXECUTIVE SUMMARY

1. At the signing of the Oslo Declaration, it was well- understood that peace would only take root if there were significant, sustained improvements in the economy of the West Bank and Gaza (WBG). Since October 1993, donor pledges have resulted in US$6.5 billion in commitments and some US$4.4 billion in disbursements to the WBG. At US$195 per person per annum since 1994, aid flows to WBG represents one of the highest levels of per capita official development assistance anywhere in the world. Today, though, the value of this enormous collective effort is threatened by the breakdown in the peace process.

2. The Palestinian economic recovery that began in 1998 came to an abrupt halt with the start of the intifada in September 2000, and the subsequent imposition of tight closure. The  economy has been decimated over the past fifteen months. Once again, though, donors have demonstrated the importance they attach to a resolution of the Israeli-Palestinian conflict through the efforts they have made to sustain the Palestinian economy and its governance structures.

The Problem

3. The Palestinian economy is in severe recession. Per capita real income declined by 12 percent for 2000 as a whole, and by a further 19 percent in 2001. The share of the Palestinian population living below the poverty line (US$2 per person per day) is currently estimated at 45- 50 percent. While the human losses to death and injury defy economic estimation, raw physical damage from the conflict is estimated at US$305 million as of the end of December 2001.1 Far more significant, though, are Gross National Income losses, which amounted to at least US$2.4 billion in real terms by the end of 2001. Average per capita real income is now 30 percent below what it was when the Gaza-Jericho Agreement was signed in 1994.

4. The proximate cause of the Palestinian economic crisis is Israel’s closure of the Palestinian territories. Only a drastically reduced number of Palestinian workers is permitted to work in Israel and the settlements, and the flow of goods into and from the Palestinian areas has been severely interrupted. Military checkpoints exist on all main and most secondary roads within the West Bank and Gaza, hampering internal communication. Periodically, all traffic from and within the territories is shut down, and many communities have experienced prolonged periods of isolation. These closures have raised economic costs and have crippled the business environment.

5. The Palestinian economic decline has been driven by unemployment in the private sector. Since September 2000, 75-80,000 Palestinians have lost their jobs in Israel and the settlements, while another 60,000 jobs have been lost inside the Palestinian territories as demand collapsed and businesses were forced to lay off workers. With more than 100,000 joining the working-age population in the course of the intifada , unemployment has climbed from 10 percent of the Palestinian workforce in September 2000 to 26 percent today (35 percent using a more relaxed definition of unemployment).

6. The Palestinian Authority (PA) is effectively bankrupt, since tax revenues have dwindled to one fifth of previous levels. Monthly budget needs under the “austerity budget” promulgated in March 2001 total US$90 million, but revenue collected by the PA now amounts to less than US$20 million per month (compared with an average of US$88 million per month in the third quarter of 2000). Under normal circumstances, about two-thirds of Palestinian revenue derives from taxes collected by Israel on the Palestinian Authority’s behalf. In the past, these taxes were remitted to the PA on a regular basis, but no such payments have been made by Israel since December 2000. Total gross revenues withheld by Israel are estimated as of end-December 2001 at NIS 2.1 billion — or approximately US$0.5 billion.

7. A full collapse of the economy and government has been averted, however. After three months of economic freefall in the last quarter of 2000, the situation stabilized somewhat, and the rate of decline has subsequently been slower. There are four main reasons for this.

8. First, the Palestinian Authority has tightened its belt and managed the crisis well, particularly in the fiscal and service delivery spheres. Second, after a virtual cessation of work in Israel in the first weeks of the intifada , an average of 50,000 workers from the West Bank have managed to find work again (without permits) in Israel and the settlements. Third, households have reduced their expenditures and drawn down their savings, and informal self-help and sharing systems have redistributed the economic pain. And fourth, the donors (often working through NGOs) have injected timely and generous emergency assistance.

9. Despite the difficulties of working in conflict, donor funding has increased dramatically. Compared with 1999, commitments rose by 77 percent and disbursements by 93 percent in 2001. 2 Over 80 percent of 2001 disbursements were devoted to budget support and emergency relief. By mid-2001, Arab League donors were contributing US$45 million a month in budget support (through the Islamic Development Bank), while the European Union has been providing another US$9 million per month. 3 This unprecedented quantity of budget support has helped sustain a minimum level of demand and has prevented the disintegration of government structures. Donor contributions to UNRWA have also been key, and numerous small- scale workfare programs for the newly unemployed have been put in place (with Germany, the US and the World Bank as major contributors). Without the intervention of the donors, and in particular the Arab League and European Union states, 4 all semblance of a modern economy would have disappeared by now. Even so, the surge in assistance comes with a price – disbursements on growth-oriented infrastructure and capacity building projects dropped from over US$400 million in 1999 to US$175 million in 2001, and many large capital projects (highways, industrial estates, the port, the Gaza airport) have been seriously delayed or damaged. In effect, long-term investment has been sacrificed to short-term survival.

10. However, the current situation is unstable, and economic disintegration continues. In the past two months, closure and conflict have once again intensified. Households have in many cases exhausted their savings and their capacity to borrow. Emergency employment schemes, for all their merits, have not made a significant dent on unemployment.5 The fiscal situation continues to deteriorate, and donor contributions have not closed the budget deficit. Up to now the PA has managed this deficit by borrowing from commercial banks, cutting salaries, squeezing operating costs and delaying the payment of bills. All of these strategies are reaching their limits. By the end of 2001, the PA’s arrears amounted to US$430 million, most of these to commercial suppliers; this in turn has increased the number of non-performing loans and is placing great stress on the commercial banking system.

11. If closure is tightened further, current PA, community and donor efforts will not suffice, and the economy will unravel. Soon little will remain of the private sector other than subsistence agriculture, petty trade and workshop manufacturing. Public services will break down, with trash accumulating, frequent power and water cuts, intermittent drug supplies in hospitals and a shortage of textbooks and writing paper in schools. Notably vulnerable are the municipalities, which have received little emergency support and are in many cases in debt to Israeli utility companies. Poverty is deepening, particularly in isolated communities. Serious health and environment problems are emerging. Helplessness, deprivation and hatred are increasing.

12. A political solution would alter this prospect fundamentally , and a rapid recovery of the Palestinian economy would accompany a lifting of closure. Even so, World Bank projections indicate that recovery to pre- intifada per capita income levels would take at least two years – assuming that private investor confidence can be restored.

The Way Ahead

13. Israel, the PA and the donors will all need to play their parts if the situation is to be reversed.

14. Any significant recovery of the Palestinian economy requires that the system of internal checkpoints be dismantled and border restrictions eased. It also assumes that the Israeli labor market will be re -opened to Palestinians. These actions would lower the costs of doing business and would stimulate a recovery of Palestinian private enterprise.

15. In addition , the tax revenues that have been withheld from the Palestinian Authority would need to be released, and regular revenue clearances resumed .

16. The donors need to provide a major program of emergency support for 2002. It is recommended that this support focus on seven packages of assistance. Taken together, these packages would provide a solid basis for an eventual resumption of growth:

Ø Budget Support . This must be continued through the year. The IMF has estimated needs at US$924 million under a status quo scenario. If closure were lifted and if Israel resumed regular revenue transfers to the PA, the requirement would fall to between US$360-420 million. The key sources remain the Arab League states and the EU.

Ø Basic Services . Targeted assistance for basic service delivery and for the key institutions responsible for delivering them is needed; the agencies include the Ministries of Health, Education and Social Affairs, and the municipalities. An Emergency Services Support Program (ESSP) has been designed for this purpose and would need c. US$155 million for 2002 6 under a status quo scenario. The aim of the ESSP is to address the severe shortages of drugs, school materials, and spare parts/fuel for water, electricity and solid waste collection systems.

Ø Re-engaging the Private Sector . Two programs are proposed for this neglected but essential area. Due to the fiscal crisis, the PA has not been able to process VAT refunds to suppliers, and this could be addressed through a concessional loan of c. US$35 million to the PA in the event that Israel continues to withhold revenues owed. The International Finance Corporation is working with the PA and other donors to design a Crisis Fund to provide immediate support to businesses, as well as during any future recovery phase. At present many businesses remain viable but need advice on how best to manage the crisis. They also need access to capital to diversify activities and exploit export opportunities. Others have lost buildings, inventory and equipment in the fighting, and need reconstruction assistance. Many others, however, cannot be meaningfully assisted until there is a resurgence of demand. Under a status quo scenario, US$40 million would be sought to provide support now, and a further US$100 million to finance the recovery phase.

Ø Unemployment and Welfare. Cash payments and job creation schemes will be needed to deal with persistent unemployment and hardship in 2002. It is recommended that the PA and the donors carry out a joint stock-taking exercise to assess experience with job creation and cash transfer programs in WBG, with a view to achieving consensus on how to crystallize the technical lessons learned so far, and on how to scale up existing efforts. Several proposals for the creation of special funds have been made by different PA officials in recent weeks, and the merits of these should be considered as part of this exercise. Under status quo some US$200 million would be needed for unemployment schemes and cash payments in 2002.

Ø Infrastructure and Land Rehabilitation . Donor reconstruction and rehabilitation funding of somewhere between US$125 million and US$200 million would be justified to restore the areas damaged by armed conflict, with due consideration given to the extent to which armed conflict has subsided. Various of the works can be packaged by area, sector or theme should individual donors prefer this.

Ø Student Scholarships . These could be provided to pupils and students unable to pay school/university fees, as a way of supporting their continuation in study and sustaining the financial viability of institutions of learning. A notional allocation of US$20 million is proposed under status quo .

Ø UNRWA . The refugee population in WBG remains heavily dependent on UNRWA for basic social services and welfare payments. UNRWA’s Third and Fourth Intifada Emergency Appeals are still under subscribed by some US$142 million, and donors should try to fund the gap.

17. Total donor financing needed for 2002 varies according to the political scenario projected. Should the peace process resume and closure be lifted, total needs would amount to about US$1.1 billion. A continuation of the status quo would require around US$1.5 billion from donors, and a significant further tightening of closure would increase total emergency needs to around US$1.7 billion.

18. Donors must also re-dedicate themselves to the medium-term development agenda. Most major infrastructure work has stalled, and many capacity building exercises have languished, in part because of the difficulty of retaining or recruiting qualified experts. Donors who have been most effective in implementing field programs during the intifada are by and large those whose programs work closely with local communities. The exigencies of the operating environment offer an opportunity here, since decentralized programs, if well-supported and monitored, can result in better poverty targeting, higher local content, and the strengthening of accountability.

19. For its part, the Palestinian Authority will need to maintain strong budget discipline in 2002 and make adequate provision for essential operating costs, as well as work further on prioritizing emergency support needs . The PA intends to develop a Palestinian Emergency Plan for 2002 with strong participation by civil society, as a way to focus Palestinian energies on economic surviva l and recovery. In addition, the PA has committed itself to concerted efforts to rationalize the roles and develop the systems and capacities of the three economic ministries – Finance, Planning and International Cooperation and Economy and Trade.

20. The PA has also indicated that it will recommit itself to the medium-term institutional and policy agenda that has been largely in suspense since September 2000. This agenda has two main planks – the promotion of transparency and accountability in the public sector, and the creation of a supportive environment for private sector development. Measures to which the PA has restated its commitment include:

Ø the continued consolidation of all sources of revenue in a single treasury account, and the maintenance of a pub lic sector hiring freeze. 7

Ø the common application of public procurement standards and guidelines, and the strengthening of the capacity of the General Control Institution (the public audit entity).

Ø the development of a unified pension system covering all public employees, as a precursor to a program of civil service “down-sizing” once the current crisis is past.

Ø the creation of a legal environment conducive to investment, by presenting to the Palestinian Legislative Council (PLC) a portfolio of laws which include a Capital Markets Authority Law, an Insurance Law, a Securities Law, a Companies Law, a Secured Financing (Leasing) Law and an Income Tax Law.

Ø ensuring adequate commercial competition, by accelerating the establishment of a Palestinian Investme nt Fund to oversee the privatization of PA assets, in particular quasimonopolistic trading activities — and by presenting to the PLC a Competition Law.

Ø ensuring that contracts are enforced and that investors are given proper legal protection, through improving the functioning of the courts and by enhancing the skills and independence of the judiciary.

21. This important agenda should now be implemented. The PA recognizes that statements of commitment to reform are of limited value if not translated into action. Accordingly the PA will, by March 31, develop a detailed Action Matrix featuring the various reforms described above and assigning responsibilities and delivery dates.

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NOTES

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1 Consisting of damage to houses and furnishings, public infrastructure, commercial properties and plant, and agricultural land including trees, wells, and irrigation systems.

2 1999 was the last full pre – intifada year. Donor commitments totaled US$692 million in 1999, US$973 million in 2000 and US$1,228 million in 2001; disbursements totaled US$482 million in 1999, US$549 million in 2000 and US$929 million in 2001.

3 Total budget commitments through the end of 2001 from donors amount to US$584 million: US$405 million from Arab League members through the IDB, US$114 million from the EU, and contributions of US$40 million from Saudi Arabia, US$15 million from the UAE and US$10 million from Norway.

4 Together, they accounted for 68 percent of 2001 disbursements. Of the US$929 million disbursed, US$388 million (42 percent) was disbursed by the Islamic Development Bank on behalf of Arab League states, and US$245 million (26 percent) by the European Union (Commission and member states). The USA disbursed another US$114 million (12 percent).

5 In 2001, some 10,000 full-time job equivalents were created under these programs. The total number of unemployed in WBG (excluding East Jerusalem) was estimated in end-2001 at some 264,000 (using the relaxed definition of unemployment).

6 Of which US$96 million would contribute to the central PA budget (and would replace part of the US$924 million otherwise needed).

7 With the exception of essential teachers, health workers and judicial staff.

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