UNCTAD Subsites - Programme of Assistance to the Palestinian people

Public finances

Recent performance (2000-2001)

Public finances

Tax revenue accrues to the PA from two sources: domestic tax collection (direct and indirect) and tax clearances remitted by the Israeli Treasury. The latter, which are by far the major source of PA taxation revenue, consist of a number of:

Domestic tax collection capacity has steadily improved since 1995, thanks to concerted efforts by the Ministry of Finance (MoF), including training of tax collection staff, public awareness campaigns, and an improved ability to identify potential taxpayers and to detect tax fraud. Tax clearance from Israel suffers from a persistent problem of leakage, since a large proportion of Palestinian imports coming through Israel are not explicitly destined for the West Bank and Gaza Strip. Accordingly, the forgone customs revenue paid by Palestinians on these imports, recently estimated to be around 3 per cent of GDP, accrues to Israel and is not transferred to the PA. A satisfactory resolution of the leakage problem and continuous improvement of domestic tax administration promise to increase fiscal revenues and help strengthen public finances.

In the meantime, the PA achieved a balanced budget in 1998 with a surplus of US$ 60 million on a cash basis. In addition, for the first time since its inception, the PA financed all current expenditure using its own resources without resort to donor support. The budget for 2000 grew to US$ 1,363 million, 70 per cent of which is devoted to payroll and operating expenditures. The budget deficit, which had reached around 3 per cent of GDP in 1996, has been reduced since 1997, as deficits accruing from current expenditures have declined. Since then, the bulk of the deficit was generated by capital expenditures, which have been financed by grants from the donor countries and from short-term commercial bank overdraft. The budget deficit was expected to be eliminated as of 2000, but arrears remain from previous years. It should be noted, however, that owing to donor assistance the effective deficit (including arrears) did not constitute a large proportion of the total expenditure budget. The deficit was projected to be US$ 52 million for 2000, which was less than 5 per cent of the total expenditure budget for that year.

While the management of PA public finances has improved in recent years, the domestic and external financial challenges faced by the emerging Palestinian economy have become greater. Development expenditures remain almost totally dependent on donor finance, which is increasingly made available in the form of loans. The PA has embarked on the Palestinian Development Plan 1999-2003, of which 93 per cent (US$ 4.3 billion) is financed by the donor community. The rest of the budget will be covered by the PA (US$ 141 million) and through concessional borrowing (US$ 200 million). Although the ratio of official development assistance (ODA) to GDP declined from around 20 per cent in 1995 and 1996 to around 13 per cent by 1998-1999 and is low compared with that of many indebted developing economies, this rate should be viewed in the light of the short period during which the PA external debt accumulated. Although debt service on most loans is low and has yet to begin, balance-of-payments pressures could fuel further official indebtedness and aggravate public debt obligations that stood at US$ 600 million by 1999.

Official development assistance

Following the international conference of donor countries held in Washington, DC, in October 1993, which pledged US$ 2.4 billion to assist the Palestinian reconstruction and development programme (1994-1999), further contributions raised the total to US$ 5.7 billion. About 82 per cent of the funds pledged are grants and the rest are loans made on concessional terms, with the PA as the main beneficiary as compared with the NGOs. To ensure responsiveness to development needs, funds are allocated in accordance with the Palestinian Development Plan (PDP), which has been presented to donors since 1994. The plan addresses four sets of needs, including infrastructure rehabilitation, human resource development, maintenance and enhancement of existing services, and institutional development of the Palestinian public sector. In 1998, the PA presented a comprehensive list of projects for infrastructure and natural resources, institution building, social development and the productive sectors as part of the PDP, which is revised periodically.

The initial understanding between the PA and the donors was that funds would not be used for short-term budgetary requirements after 1994, but for long-term public investment, which includes financing infrastructure projects, supplying capital assets in kind and providing support to the private sector. This understanding could not be adhered to during the period 1996-1997 because of severe economic conditions caused by border closures. The ensuing problem of widespread unemployment and the spread of poverty shifted attention, with short-term income maintenance projects being favoured instead of public investment. Total disbursements reached US$ 1.527 million during this period, of which half was allocated to short-term support, 34 per cent to public investment and the remainder to technical assistance. The relative improvement in general economic performance since 1997, especially the notable decrease in the PA budget deficit, has directed attention once again to long-term investment.

The period 1996-1999 witnessed a shift in donors' focus away from budget support to infrastructure development projects, which accounted for 39 per cent of total disbursements by the end of second quarter 1999, up from 19 per cent in 1994-1995, though with no absolute increases. In contrast, budget support was reduced to less than 4 per cent by mid- 1999. Funds allocated to human resources and social development decreased from 33 per cent to 21 per cent during the same period; similarly, funds allocated to institution building declined from 20 per cent to 13 per cent.

Assistance efforts have been facing immense challenges given the adverse development environment. The complex nature of coordinating mechanisms adopted by the involved parties involved is another factor militating against aid effectiveness and delaying the disbursements of pledged funds. By 2000, around 80 per cent of total pledges (US$ 4.6 billion) had been committed against specific projects. The declining trend of donor assistance (declining by almost 20 per cent from US$ 512 million per year in 1996-1997) is another challenge threatening the sustainability of development efforts. For although such a trend can be attributed to the shift in composition of donor assistance to longer-term projects, it reflects the fact that external assistance cannot be maintained at the same level, let alone be relied upon indefinitely.

Recent performance (2000-2001)(1)

Developments in the Palestinian territory during 2000-2001 have been dominated by a range of unprecedented restrictions on flows of goods, labour and financial resources, generating a widespread economic crisis with immediate and longer-term implications for economic development. Restrictions on movement were especially pronounced in the closure of international borders between the Palestinian territory and Israel, Jordan and Egypt, effectively isolating the Palestinian territory from the rest of the world. Border closures were in effect for three quarters of the working days during the period from 1 October 2000 to 31 January 2001 alone, while Gaza International Airport was closed for half of the working days during the same period.

The flow of goods was also hampered between periods of full closure, with tightened security arrangements at commercial crossings limiting the working hours and the number of truckloads allowed to cross the borders. Flows of goods and labour were further restricted by internal closure measures, whereby roads to cities and villages in the West Bank and the Gaza
Strip were permanently or temporarily sealed off for most of the period, creating 54 fragments of isolated areas under PA jurisdiction. Meanwhile, the failure to operate the safe passage between the West Bank and the Gaza Strip (except for a brief period in 1999-2000) undermined the tenuous economic integrity of the West Bank and the Gaza Strip, which the interim period accords were intended to guarantee.

The impact of border closures and other restrictions on movement was compounded by economic sanctions applied for different periods since late 2000. Most notable in this respect was the withholding of indirect tax and customs revenues owed by Israel to the PA, estimated to have reached US$ 190 million by April 2001. Trucks and commercial shipments destined for Palestinian importers via Israeli ports were delayed or withheld for security and other controls for indeterminate periods. Producers and consumers also faced repeated shortages of raw materials, such as cement and chemicals, as well as fuel supplies, cereals and other bulk imports that are sensitive to border restrictions or prohibitions on entry into the territory.

These measures have taken a mounting toll on the Palestinian economy, depriving it of its main sources of income. The economy's resources have been drained, with losses estimated at US$ 2-3 billion in the first six months since late 2000. This includes losses accrued from declining labour income from Israel (accounting for around 20 per cent of total losses) and from declines in most domestic sectors. In addition, indirect losses (destruction of infrastructure) are estimated at well over US$ 200 million for the same period. With domestic output cut by almost half in October-December 2000, per capita gross national income (GNI) is estimated to have declined by around 20 per cent in 2000 compared with the previous year. In a survey of economic losses undertaken by the PCBS covering the period October-November 2000, manufacturing and construction activities were shown to have incurred the highest losses, together accounting for about 40 per cent of the decline in GDP.

The rate of unemployment grew rapidly and sharply. Some 300,000 Palestinians, equivalent to around two fifths of the labour force, were reported to be jobless by mid-2001. Poverty indicators grew sharply during the period from 1 October 2000 to 31 January 2001, with more than 1 million people, or one third of the Palestinian population, living below an estimated poverty line of US$ 2.10 per day. When measured in terms of the deterioration of household income, it is estimated that the income of 64 per cent of Palestinian households had fallen below US$ 400 per month (for a household of six). The economy has fallen into growing indebtedness, with the private sector experiencing a liquidity crunch, while the PA budget deficit is expected to increase to US$ 524 million by the end of 2001, or around 25 per cent of the year's projected emergency budget.

Key members of the donor community were quick to respond to urgent needs generated by the crisis, providing budget support and implementing emergency projects to assist the disadvantaged and unemployed. The Arab States Summit Meeting in October 2000 decided to raise US$ 1 billion in relief and aid, although the disbursement of committed has been insufficient to respond to the scale and scope of needs. While around US$ 700 million had been pledged by mid-2001, US$ 270 million had been disbursed, partially in the form of "soft" loans, to provide budgetary support for a nine-month period, in addition to at least US$ 40 million granted for emergency assistance. Meanwhile the European Union granted 87 million euros to help the PA meet urgent expenses, and the World Bank approved a grant of US$ 12 million to provide employment for Palestinian workers previously working in Israel through emergency job creation projects. These important support measures were paralleled by initiatives by donors and international organizations, involving emergency job creation, food aid, social services and budgetary support.

While it is clear that the costs of the crisis are significant, it is less apparent how the economy will recover and how long that will take. The United Nations Special Coordinator in the Occupied Territories stated as early as December 2000 that "what was achieved in progress in the living conditions of the Palestinians over the last three years has been completely destroyed over the last two months". The crisis diverted the donor community's attention away from development projects to emergency job creation, resulting in the suspension of infrastructure and long-term technical assistance projects that were designed to improve the economy's supply capacity. Restrictive measures, meanwhile, aggravated structural weaknesses, threatening further deterioration in living conditions. Key investment projects were suspended, given the heightened political and economic risks.

Tourism, transport and related services, highly sensitive to such turbulence, faced particularly significant pressures after several years of sustained new investment in the sector. Meanwhile agricultural performance deteriorated further, with farmers forced to leave the harvest in the fields to avoid incurring additional costs. Agricultural exports registered sharp decline at a time when increased exports were needed to help finance investments to develop the sector's productivity. This in turn impeded the structural transformations required for reversing chronic weaknesses within the economy, in particular its heavy reliance on external resources for stimulating growth and hence its vulnerability to shocks.

The capacity of the PA to address the development needs of the Palestinian people, which was limited to begin with, has been further curtailed. Its ability to sustain social services is seriously threatened, with resources reallocated to emergency projects. By mid-April 2001, the PA had incurred US$ 630 million to cover the costs associated with improving the impaired heath, social and education services, provision of food stocks for the poor, and rehabilitation of damaged infrastructure and other losses. Meanwhile, public debt obligations are rising steadily, with loans accounting for a growing share of aid. In view of the declining trend of donor aid, the sustainability of development efforts is further threatened. Given the weakening terms of trade for labour-intensive products and poor market access conditions for exports, the task of developing the Palestinian economy appears more formidable than ever.

Policy challenges

If anything, the crisis has reaffirmed the strong interdependence between development and peace. However, restoring peace and stability alone will not necessarily lead to a smooth recovery, let alone sustainable development, unless supported by a comprehensive strategy geared towards building institutions and executing policies aimed at bolstering the new environment and fully realizing its potentials.

The need to strike a balance between immediate needs and the requirements of long-term development has been underscored by recent quantitative investigation by the secretariat, which, despite the discouraging developments of the past year, demonstrates the possibility of setting the economy on a sustainable development path through responsive policies which target long-standing structural weaknesses.

Though committed to creating a market-oriented, private-sector-driven economy, the PA development strategies lack the operational framework needed to provide the basis from which to overcome structural weaknesses. At the same time, the framework and underlying premises of economic policy since 1994, namely the Protocol on Economic Relations between Palestine and Israel, have been thrown into serious doubt by recent events and are under harsh scrutiny by both sides. Indeed, the crisis has generated a wider consensus among policy makers and experts on the need to reorient the Palestinian economy towards more balanced relations with Israel by integrating it into regional and global markets.

Consequently, more vigorous targeted efforts will be required, aimed at encouraging viable employment opportunities in the domestic economy, beginning with those sectors which had to release labour during the crisis, as well as other branches whose potential contribution to growth, exports and job creation had already been established. At the same time, these efforts should be supported by a comprehensive trade policy and sectoral development strategy that would fully address the present infrastructure, institutional framework and supply constraints; fiscal and monetary policies for encouraging savings, investment and trade; and a negotiating agenda that would ensure the protection of national interests.

Any attempt to look forward to the task of strategic development policy-making should take into account the following points which flag some of the issues that have special relevance in the Palestinian context: