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PALESTINIAN ECONOMY
THE ECONOMY (part II)
Trade
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Trade regime
Import regime
Of particular relevance to Palestinian economic and trade
policy is the Protocol on Economic Relations between the
Government of Israel and the Palestinian Liberation
Organization, representing the Palestinian people, also
known as the Paris Protocol, signed on 29 April 1994. This
"establishes the contractual agreement that will
govern the economic relations between the two sides and
which will cover the West Bank and Gaza Strip during the
interim period", set at five years starting from 4
May 1994. In doing so, it defines the main features of the
economic policy environment with regard to trade,
envisaging a trade regime that most closely resembles a
customs union.
Under the terms of the Protocol, the PA has the right to
determine independently the rates of customs duties,
purchase tax, levies, excise and other charges on imports
of limited quantities of commodities from specified
sources in Lists A1 and A2 (Article III-2, a and b); and
imports with no restrictions on quantities of goods in
List B (Article III-4). When first negotiated, List A1
contained some 24 goods whose origin, or at least 30 per
cent of whose value added, derives from an Arab State. Of
these, 11 items have to come exclusively from either Egypt
or Jordan. List A2 contains mostly food-related items,
which the PA has the right to import from anywhere in the
world, bearing in mind that 11 items on List A2 also
appear on List A1. As for List B, it includes a large
number of items needed for investment and development
(Article III-4). In mid-2000, the scope of the lists was
expanded to include 1,400 additional tariff line items.
For other imports, such as automobiles and petroleum
products, special import regimes and standards are
adopted. These allow the PA to set its own rate of customs
and purchase taxes on motor vehicles imported into, and
registered with, the PA. The PA is also allowed to import
used passenger cars up to three years old, subject to
approval by a joint Palestinian-Israeli committee, and is
free to determine the price of petrol derivatives, except
gasoline (Article III-11, a).
As regards petrol and non-listed products, the Protocol
provides that the price of petrol derivatives must not
exceed 15 per cent of the consumer price in Israel
(Article III-12, b). Products not on Lists A1, A2 or B, or
those on the first two lists but exceeding the quotas, are
subject to a minimum of Israeli rates. To date, the PA has
not made any change to the prevailing customs duties on
non-listed goods and the Israeli tariff schedule is
therefore being applied to most PA imports.
The Protocol also provides that Israeli import
classification, valuation and other customs procedures,
and licensing and standards policies shall apply to all
Palestinian imports, except for the quantities agreed upon
under Lists A1, and A2 (Article III-10). As for the
clearance of customs revenues and fees levied on imports,
these are based on the principle of final destination.
This means that collected tax revenues should be allocated
to the PA, even if the importation was carried out by
Israeli importers, when the final destination explicitly
stated in the import documentation is a corporation
registered by the PA and conducting business activity in
the West Bank and Gaza Strip (Article III-15).
Export regime
The Palestinian Ministry of Economy and Trade defines and
implements export policy and procedures. No subsidies are
available for exporters, nor does the PA provide subsidies
in any productive or service sector. There are no export
restrictions, and licenses are not required for exporting.
When applicable, exporters must submit a certificate of
origin obtained from the local Chamber of Commerce.
Built-in limitations
The Protocol was intended to provide a basis for
strengthening the Palestinian economy and diversifying its
external trade. A direct benefit that the PA can reap from
this regime is the opportunity to exploit bilateral trade
agreements between Israel and other countries since they
apply to the PA. Moreover, adopting the Israeli import
classification and standards means that the valuation of
all PA imports is based on GATT 1994, while classification
of goods for customs purposes is in line with the
principles of the Harmonized Commodity Description and
Coding System (HS). This implies an import regime wholly
compatible with international standards. However, the
Protocol entails the following limitations:
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The PA cannot grant preferential or duty-free
treatment to imports from most countries with which Israel
does not enjoy such an arrangement, except Jordan and
Egypt.
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The Protocol does not address the wide range of
subsidies and other non-tariff barriers that benefit some
Israeli sectors and products, effectively leaving
Palestinian industry and agriculture at a disadvantage.
Although support measures are being phased out gradually
as Israeli trade is liberalized in line with WTO
commitments, they continue to operate in some areas with a
bearing on similar Palestinian productive branches.
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Although the Protocol calls for free movement of goods
between Israel and Palestinian self-rule areas, such
movement was been above all subject to "security
measures", thereby restricting the quantities of
Palestinian goods exported through Israel, interrupting
the smooth flow of imports and preventing Palestinian
labour flows to Israel.
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The Protocol limits the PA's ability to generate
revenues since the possibility of the PA's levying higher
tariff (or indirect taxation) rates than Israel is
effectively constrained by the absence of provisions
preventing the entry of the same goods via Israel.
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The re-export clause (Article III-15) facilitates fiscal
leakage as it does not ensure the PA's receipt of customs
revenues on goods that are not of Israeli origin, but
imported from outside Israel to the West Bank and Gaza
Strip via Israeli intermediaries. In theory, customs
revenues generated from these goods should accrue to the
PA since they are actually of non-Israeli origin or
Israeli re-exports. However, the PA's inability to
adequately monitor imports from Israel has resulted in a
fiscal leakage estimated at between US$166 million and
US$275 million a year during the period from 1994 to 1996. Since 1997, the PA has been able to gradually
capture the fiscal revenue accruing to actual imports to
the West Bank and Gaza Strip by imposing agency
requirements on local importers.
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Trade performance indicators
The Palestinian economy has a relatively high degree of
exposure to foreign trade, with a ratio of total
merchandise trade to GDP of 80 per cent in 1998. This
openness to trade is accompanied by an import bias
manifested in the rising ratio of (merchandise) imports
from below 40 per cent in 1990 to approximately 57 per
cent in 1999/2000, while the exports ratio to GDP, which
was above 40 per cent in 1980, declined to stagnate at a
historically low level of about 10 per cent as from 1990.
In 1998, merchandise imports amounted to an estimated US$
2,375 billion, while exports did not exceed US$ 495
million. Although manufactured investment goods, utilized
in infrastructure projects, accounted for 36 per cent of
the value of total imports in 1998, the growing deficit is
mainly attributed to the economy's heavy reliance on
imports to meet local demand reflecting unrestrained
consumption. This has had a negative impact on the trade
balance, which manifests a persistent deficit, growing
from US$1,658 billion in 1996 to US$1,980 billion in 1998.
Compared with 1990, the trade deficit has tripled.
Consequently, the ratio of trade deficit to GDP has
increased up to well over 50 per cent since 1995, from 27
per cent in 1990.
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Trade partners
Palestinian trade is heavily concentrated with one
partner, namely Israel, accounting for nearly 80 per cent
of the total value of trade in 1998. Trade with Jordan, on
the other hand, accounted for only 2.4 per cent of the
total value of Palestinian trade in that same year. A
breakdown of trade flows reveals a positive shift during
the period 1997-1998 with imports from the rest of the
world representing 29 per cent of total imports in 1998 as
compared with 12 per cent in 1996. This development
reduced Israel's share of the total value of Palestinian
imports from 86 per cent in 1996 to 69 per cent in 1998.
However, on the export side, Israel remains the main trade
partner accounting for 95 per cent of total exports in
1998 compared with 85 per cent in 1990. Exports to the
rest of the world have been declining sharply at levels of
US$ 1-4 million annually since 1993, thereby accounting
for less than 0.5 per cent of total exports in 1998.
The volume of trade between the Palestinian areas and
their immediate neighbour Jordan stood at around US$ 66
million at the end of 1998 compared with US$ 42 million in
1997. This increase in the total value of trade is also
characterized by a trade deficit in the favour of Jordan.
Except in 1996, the PA's trade deficit with Jordan has
been increasing - from US$ 7.8 million in 1997 to US $8
million in 1998. Trade with Egypt, which became possible
in 1994 after the opening of the borders that were sealed
following the 1967 war, did not fare any better, with a
total volume of trade not exceeding US $28 million at the
end of 1998 compared with US$ 31 million in 1997. Although
Palestinian exports to Egypt doubled in 1998 compared to
1997, they were still insignificant by the end of 1998.
This heavy concentration of trade with one partner is in
contrast with the numerous trade agreements signed by
Palestine, for the benefit of the PA of the West Bank and
Gaza, and the rest of the world, including the Protocol on
Trade Relations with the Arab Republic of Egypt; the Trade
Agreement with the Government of the Hashemite Kingdom of
Jordan, the Euro Mediterranean Interim Association
Agreement on Trade and Cooperation with the European
Community, the Interim Free Trade Agreement with the
States of the European Free Trade Association; and the
Joint Canadian-Palestinian Framework for Economic
Cooperation and Trade.
Furthermore, on 3 October 1996, the President of the
United States issued a presidential decision granting
duty-free treatment to products of the West Bank and Gaza
Strip entering the United States market. The PA
reciprocated unilaterally and granted United States
products duty-free treatment upon their entering the West
Bank and the Gaza Strip.
In July 2000, the Palestine Liberation Organization, on
behalf of the Palestinian Authority, signed an agreement
with the Government of the Hashemite Kingdom of Jordan for
the purpose of establishing a joint Free Trade Area (FTA)
in the Jordan Valley. Work is planned to proceed in a
phased manner with a view to operating the FTA by the year
2007. The two sides signed a transport agreement in the
same month, under which they adopted the principle of
"door-to-door" trade modalities as of 1 August
2000.
On 18 January 2001, the Palestine Liberation
Organization, on behalf of the Palestinian Authority,
signed a cooperation agreement with the Government of the
Hashemite Kingdom of Jordan in the field of customs.
Believed to be the first of its kind between the PA and an
Arab country, the agreement envisages cooperation that
includes the exchange of administrative and technical
expertise, and the rationalization and harmonization of
customs procedures, together with curbing of smuggling.
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Commodity composition of trade
A review of the commodity composition of Palestinian
trade in terms of value (by SITC divisions) ranks
manufactured goods as the largest category of exports with
a 42 per cent share of the total value of exports in 1998.
Food and live animals ranked as the second largest
category of exports (16 per cent), followed by
miscellaneous manufactured articles (15.6 per cent),
beverages and tobacco, together with chemicals and related
products (6 per cent each) and raw materials (4 per cent).
Exports of vegetables and fruit totalled US$35 million,
representing 8 per cent of total exports, followed by
furniture (US$24 million), iron and steel ($US18 million)
and footwear (US$19 million). Meanwhile, stone and marble
continue to be the single most significant Palestinian
export, worth over US$100 million in 1998.
At the same time, manufactured goods also ranked as the
largest category of imports (23 per cent), followed by
food and live animals (19 per cent), mineral fuels
lubricants (17 per cent), and machinery and transport
equipment (16 per cent). Other major import items include
miscellaneous manufactures (7 per cent), chemicals and
related products (6 per cent), and beverages and tobacco
(4 per cent).
Financial market
The Paris Protocol assigned many functions to the
Palestinian Monetary Authority (PMA) that are the traditional
responsibilities of a central bank, designating it as the
supervisor and controller of the financial system, and as
banker to both the PA and the commercial banks. The PMA is
thus entrusted with the task of licensing all banks operating
in the West Bank and Gaza Strip, holding their reserves, and
regulating their operations with regard to solvency, liquidity
and stability. More specifically Article IV-5 of the Protocol
states that the PMA should operate a discount window to
advance loans to commercial banks, and act as a lender of last
resort. Article IV-4 states that the PMA will act as the sole
financial agent (locally and internationally) for the
Palestinian Authority, as well as being its financial adviser.
It also holds and manages the foreign currency reserves of all
public sector entities.
The ability of the PMA to perform some of these functions,
such as that of lender of last resort, is severely restricted
by the absence of a national currency, and the stipulation
that the liquidity requirement on shekel accounts be linked to
that used in Israel (Article IV-11.a). At present, the
Jordanian dinar (JD), the New Israeli Shekel (NIS) and the
United States dollar (US$) are the main currencies circulating
in the economy.
The PMA could exercise some control over the monetary base
by using certain instruments. These include the management of
government deposits, open-market operations in foreign
currency and the discount window. However, these instruments
are useful only in the short run, and only for very small
operations. A major excess demand for reserves cannot be met
by any of these tools, unless the PMA is willing to borrow
heavily either from Jordan or from Israel (depending on which
currency is demanded) and, in so doing, to place a burden on
the fiscal system.
The inability of the PMA to exercise the control
traditionally exercised by a central bank over the monetary
base implies also that its ability to manage public debt on
behalf of the Government is circumscribed. More importantly,
its role in using monetary instruments to counterbalance
short-run fluctuations, and to effect long-run readjustments,
is severely undermined.
Moreover, there is another problem associated with the use
of a double currency standard, that of currency mismatching.
It stems from the fact that commercial banks might find
themselves with liabilities denominated mainly in the
appreciated currency while assets are mainly constituted in
the depreciated currency. The risk of this will prevent
commercial banks from performing the function of maturity
transformation (accepting short-term deposits and extending
loans over longer terms).
Nevertheless, the banking sector registered an impressive
deposit mobilization record in 1996 following the
establishment of the PMA, with total deposits growing by
around 700 per cent from US$ 219 million in 1993 to US$ 1,707
billion in 1996, excluding deposits of non-residents (US$ 3,85
million). This was mainly attributed to the opening of new
banks encouraging residents to transfer their deposits from
abroad into the local banking system. Deposit mobilization
continued to increase, albeit at a slow rate, reflecting
economic difficulties. Total deposits of residents grew by
around 16 per cent in 1998 compared with 1997 and by 18 per
cent in 1999 compared with 1998 to reach US$ 2,832 billion, of
which around 70 per cent was generated from term deposits or
saving accounts since banks do not issue negotiable
securities.
The overall bank credit to the private sector grew by 32
per cent in 1999 as compared with 1998 to stand at US$ 613.8
million, while the overall lending-to-deposit ratio reached 35
per cent, up from 31 per cent in 1998. Major banks pursue a
relatively conservative lending policy, as indicated by the
low share of total loans to total assets (26 per cent) and
total deposits (29 per cent) in 1999. Loans show a relatively
short-term credit structure distributed among (a) overdrafts
(53 per cent), which have a repayment period of less than one
year, and (b) loans with a repayment period of 1-3 years.
Commercial activities accounted for 43 per cent of outstanding
bank credit in 1999, followed by construction (20 per cent)
and manufacturing and mining (17 per cent), reflecting a
concentration on financing enterprises' working capital.
These prudent lending policies can be explained by the high
level of political risks perceived by the banks, especially as
they continue to operate without a clear set of commercial
laws. Long-term loans are also impeded by a shortage of
acceptable collateral resulting from the lack of proper land
registration, which could establish property rights clearly,
and by the difficulties in estimating accurately the standing
of companies and individuals. The salient features of the
borrowing enterprise undermine their creditworthiness, thereby
impeding the development of the economy's industrial base
through boosting the level of capitalization.
The capital market is represented by the Palestinian
Security Exchange (PSE), which was established in 1997, with a
well-established institutional set-up in terms of physical
infrastructure, technology and level of managerial skills. The
PSE has competitive listing requirements with a view to
attracting foreign investors and facilitating the repatriation
of Palestine's dispersed wealth in the Palestinian diaspora.
In 2000, the PSE's market capitalization stood at US$ 766
million with 25 listed companies, while the value of total
trading did not exceed US$ 189 million. The unfavourable
investment environment, the lack of clear commercial laws and
the limited number of enterprises that can meet the listing
requirements help to explain this performance.
Investment
The PA is implementing an open investment policy with the
aim of attracting foreign investment and reorienting domestic
savings and investment to augment Palestinian development
efforts.
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Investment Law
As a result of the national commitment to encouraging
investors and building a modern market economy, the 1998 Law
on the Encouragement of Investment superseded the law of 1995.
The new law offers guarantees to all new investors and
stipulates a series of incentives of different duration,
mainly in the form of tax holidays, based on the capital
invested and the labour employed. It also offers different
unrestricted distribution of benefits to investors.
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Industrial Estates and Industrial Free Zones Law
The Law on Industrial Estates and Industrial Free Zones was
ratified in November 1997. It designates certain areas as free
zones to facilitate the establishment of regional and
international export centres. The Palestinian Industrial
Estate and Free Zone Authority was established as an
autonomous body to oversee the establishment of estates and
free zones, and create an enabling and regulatory framework
for the success of their operations. The Gaza Industrialized
Zone has already confirmed the feasibility and attraction of
such a concept in a still uncertain investment environment.
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Investment guarantee regime
At the request of the PA, the Multilateral Investment
Guarantee Agency (MIGA) created the West Bank and Gaza
Investment Guarantee Trust Fund. The Trust Fund provides
guarantees for eligible foreign investors against major
political risks such as expropriation, war and civil
disturbance in member countries, and helps to attract foreign
direct investment in the Palestinian economy.
Private investment
In 1998, private investment was estimated to have reached
US$476 million, accounting for 13 per cent of GDP, while gross
capital formation represented 35 per cent of GDP, up from 29
per cent in 1994. Private investment is heavily concentrated
in construction activity, with residential construction
accounting for 85 per cent of total planned construction areas
for the period January-September1999. Planned business
construction areas increased by only 6.8 per cent in relation
to the same period in 1998, compared with a 16 per cent growth
in planned residential construction.
In 1999, the number of new registered companies grew by 38
per cent. However, this did not necessarily have an impact on
levels of private investment, given the time lag between a
company's registration and its establishment. More important
are the minimal capital investment and employment that
continued to characterize business investments by small
private companies, which accounted for 54 per cent of total
new registered companies. Investment projects approved by the
Palestinian authorities in 1999 (worth US$ 298 million) do not
offer much with regard to addressing unemployment, despite the
85 per cent increase in their value compared with 1998; once
executed, they will create only around 3,000 new jobs.
Foreign direct investment (FDI) remains limited, mainly
concentrated in the construction, real estate and tourism
(hotel) sectors, as well as franchising arrangements with
local producers or distributors. In the absence of
comprehensive aggregate statistics on the subject, some
indicators are available, such as the modest number of foreign
firms operating in Palestine. The Palestinian Central Bureau
of Statistics (PCBS) industrial survey indicates that foreign
companies share the salient features of local companies,
characterized by minimal capital and employment. This is to be
expected given the high degree of economic and political risks
engendered by political turmoil, the adverse trade
environment, the limited range of services offered by
financial institutions and the still-evolving legal framework.
The persistent delays in implementing public investment
infrastructure projects are another factor discouraging
foreign companies from undertaking capital-intensive projects.
This low level of investment masks a number of positive
developments. Most notable is the emerging trend with regard
to the organizational modes of investment activities in the
Palestinian territory, characterized by the growing
involvement of Palestinian diaspora businessmen in the growing
enterprise sector. This is especially true in the case of
businessmen based in Jordan, and to a lesser extent in Egypt
and the Arab countries of the Gulf, mainly because of
proximity and easier communications and interaction with the
Palestinian territory. The fact that many of these businessmen
have numerous acquaintances and family connections in the
territory has facilitated their business contacts. The
situation since 1994 affecting traffic across border crossings
at the bridges and Israeli airports has reinforced motivations
to return to the Palestinian territory, even if only for the
purpose of doing business. Furthermore, this trend gained
momentum as a consequence of the resumption of banking
activity in Palestine under semi-normal circumstances. In
fact, many diaspora investors opted to join forces with newly
opened banks when deciding to do business in the territory.
Such partnerships afford greater security and institutional
clarity to new investors, most of whom are unfamiliar with
local conditions.
An early and prominent example was a leading investment
firm established in October 1993 under the name of Palestine
Development and Investment Limited (PADICO). The owners are a
conglomerate of individual and corporate Diaspora Palestinian
investors, mainly based in Jordan and led by the Arab Bank
Ltd. The initial share capital of PADICO was US$ 200 million,
to be expanded at a later date to US$ 1 billion dollars.
PADICO envisaged managing a total project portfolio of US$ 1.4
billion dollars by the end of the decade.
In order to attain maximum efficiency in its operations,
PADICO established three autonomous enterprises-catering for
construction (based in Gaza), tourism (based in Jerusalem) and
industrial projects (based in Nablus). Each is managed by its
own board of directors and its own shareholders, with PADICO
as the major partner represented on respective boards in
proportion to its subscribed capital. All three firms and the
holding company have managed to establish efficient working
relations with the PA. Subsequently, PADICO negotiated
contracts with the PA in fields as diverse as electricity
generation, telecommunications and the construction and
management of export-processing zones, as well as planning and
management of the Nablus security exchange. The PADICO
corporate model has been duplicated by a number of holding
companies, which have been established during the past two
years outside the territory. These firms are owned and
financed largely by expatriate Palestinian investors, with the
tangible input and involvement of the domestic business
community. Like PADICO, they look forward to playing an
important role in industry, construction, tourism and
utilities, but they have not yet begun business operations.
The interim period has also witnessed the emergence of
locally financed investment initiatives, exemplified by a
holding company that was established by a group of West Bank
investors to complement and diversify the emerging corporate
structure in the territory. The Palestine Investment and
Development Company (PIDCO, not to be confused with PADICO)
was started in 1993 with a relatively modest capital base of
around US$ 8 million, with the intention of encouraging
investment in industry, real estate, tourism, finance and
trade. A local insurance company and 34 major shareholders
made the initial subscription to half of the six million
shares of the company, with the rest sold directly to the
public by the company (prior to the establishment of the
securities exchange market). PIDCO has since invested in a
range of ventures, in partnership with other individual and
corporate investors. This has included a local construction
contracting company (in Ramallah), the first Palestinian
aluminum processing company producing for the local and export
markets (in Al-Bireh), a tourism investment company (in
Jerusalem) which aims at developing hotels, tourist sites and
resorts, and a locally based investment bank (in Gaza and
Jericho).
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