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IMF Report on the Economy in the Palestinian Authority

(September 20, 2003)

Extract from a press briefing on the West Bank and Gaza by Adam Bennett and Karim Nashashibi of the IMF's Middle Eastern Department with William Murray, Deputy Chief of Media Relations, Dubai International Convention Centre, Dubai, United Arab Emirates. To read the complete report (reprinted with the special permission of the IMF), click here [PDF Format requires Adobe Acrobat reader].

MR. NASHASHIBI: Thank you. This is a study which basically covers the last three years of economic developments in the West Bank and Gaza. It covers the impact of the conflict on the economy and the banking sector, and it also covers all the fiscal and budgetary developments during a time of crisis.

The other kind of main coverage of this study is the whole reform process. As you know, a reform process was reactivated last June of 2002, with donor participation, but essentially promoted by the Palestinians themselves.

Now, why did we want to do this study? We really wanted to do it for two reasons:

The first is to try to measure the impact of this conflict on the economy.

We had many different estimates of declines due to, of course, the recession that ensued, the conflict. Tourism stopped to a standstill. Palestinian workers could not work in Israel any more. There were checkpoints, and curfews, and roadblocks in various areas in the West Bank which basically fragmented the whole West Bank and, you know, paralyzed economic activity and paralyzed trade. So all of this, obviously, had a pretty disastrous effect on the economy, and there were estimates of declines reaching 50 percent of GDP.

On the other hand, we noticed that there are many kind of indicators of resilience of the economy. For instance, bank deposits only declined initially by 10/15 percent and started rising again. If you look at cement consumption and fuel consumption, there have been much less than these large estimates, and so we wanted to find out what is it that made this economy still function and be resilient in the face of very severe external shocks. So this was basically the fundamental reason.

The other reason was that they wanted to get to the bottom of this whole reform process; in particular, reform was spearheaded by the current Minister of Finance, Dr. Salam Fayyad, since June of 2000. And, of course, he took main responsibility over the fiscal and financial area, but reform also spread to various other areas, and we wanted to find out how deep the process was, what were the actual needs for reform and what are some of the remaining outstanding issues in the reform process.

Finally, I should say that this study could not have been possible without the new atmosphere of openness and transparency that has permeated the PA, particularly in the financial and fiscal sphere, under Minister Fayyad, who, incidentally, was my predecessor, as resident representative, for a period of six years in the West Bank and Gaza, so he obviously knows all of the issue quite well.

So this openness actually led to posting the budget, on a monthly basis, the budget, as well as budget execution, on the website of the Ministry of Finance. You can all obtain the details of expenditures and revenues, which is quite extraordinary in this region.

For instance, in the study, for the first time, we have a table which covers the period from '95 to 2000, outlining the diversion of revenue from the budget to a special bank account controlled by President Arafat. We estimated that amount to be around $900 million over a period of five years. So, I mean, this is the type of things that we were able to do in this new kind of atmosphere of openness.

Finally, let me say a couple of words about what the IMF does in the West Bank and Gaza. From the inception of the PA, we have been helping in building Palestinian institutions, particularly on the financial side, with a budget, with a Revenue Department, with tax administration. We're currently helping the Minister draft an income tax law which is very much in conformity with best international practices.

So, I mean, this is a major function, is basically to provide advice, technical assistance, and help in building transparent and accountable Palestinian institutions.

The second purpose is to participate with the donors in the task force, which reports to the quartet--the Task Force on Palestinian Reform. For instance, I am the co-chair of the Financial Accountability Support Group, and I brief the donors every two or three weeks on the latest fiscal developments and reforms which go on.

And, finally, I coordinate very closely with my Israeli counterparts. There is very good cooperation. I keep them briefed on what is happening on the Palestinian side, and of course I brief myself on what is happening on the Israeli economic side, which affects directly the function of the Palestinian economy.

So maybe Adam will give some of the highlights of the conference.

MR. BENNETT: Thanks, Karim.

First of all, as Karim mentioned, one of the things we were most interested in is what has actually been happening to the Palestinian economy during these three very difficult years of conflict, and estimates have been floating around that the economy could have contracted by as much as 50 percent, which would be a very, very major collapse.

We looked at a number of different sources of information and indicators, and we've come to the view that the economy is, indeed, has been very severely affected by this conflict, but the decline could be on the order of 30 percent and maybe even less than that.

So, although the regime of closures, and checkpoints and other security infrastructure that has been imposed on the economy has definitely had a negative effect, the economy has been much more resilient than one might have expected. In fact, by looking at data for the first half of this year, there are signs it is even beginning to recover somewhat.

Another area that we looked at was the financial sector. And, again, one might have expected banks to have been, well, to have found conditions that are extremely difficult, and so, indeed, they have. However, they have weathered the storm extremely well, and one of the reasons for this is that, in the years before the conflict, when the economy was actually booming, they, nonetheless, proceeded with very conservative lending strategies which prevented them from becoming overexposed when the situation turned for the worse, as indeed it did in September of 2000.

And because the banking system is still functioning, the residents in the West Bank and Gaza can continue to conduct their daily lives, making deposits, withdrawing money, writing checks, and so on. And that's another reason why the economy has been able to withstand this difficult situation better than might have been expected.

And another perhaps rather surprising fact is that the, as some of you may not be aware, but there is, in fact, a stock market in Nablus, in the Northern part of the West Bank, and that continues to trade virtually every day for a few hours every day, and that's a sign that the economy is continuing to function, despite what has happened.

Turning to the fiscal area, the Minister of Finance has been able to prepare and execute budgets, despite these very, very difficult circumstances. And this has been helped by the fact that the clearance revenues collected by the Israelis, which are due to the Palestinians, which were initially withheld at the beginning of the conflict, were resumed at the end of last year, and this has been very important to enable the Palestinian Authority to manage a budget in a viable way.

And the other key factor in this has been the role of international donor support for the budget, which is essential.

Turning to, Karim mentioned also the reform program, and the reforms in the fiscal area have been very, very impressive. And they're focused on, amongst other things, on improving the transparency of the whole budget process. And I think it's fair to say that, as a result of these reforms, the level of transparency and probity in the fiscal process of the Palestinian Authority is probably the equal of the best in the region. They've made major progress in that area.

But there are still, of course, areas where other reforms are still needed.

In some areas where progress is underway, one area that is important is pension reform. This is quite well advanced. Another area where things are proceeding rather more slowly is in the reform of the civil service and the grappling of high levels of civil service employment, which is a problem for the budget, and this needs to make further progress.

Another area where there's been some progress is in the remuneration of the security services, where now half of the security forces are paid by direct bank transfer, which means that it's clear to the Ministry of Finance who is being paid, and those who are being paid are readily identifiable as owners of the bank deposits--the bank accounts. So there's various areas on the fiscal side where reform is more or less advanced, but there are still areas that need to make further progress.

In other areas, reform is also proceeding, some more rapidly than others. One important area is a raft of reforms that is designed to push the Palestinian economy into a modern market economic framework, and there's a whole raft of laws at various stages of development, covering competition, company law, securities law, intellectual property rights and many other related areas which are in the pipeline and which should make the, when they all come to fruition, should make the Palestinian economy one of the most modern and market-oriented economies in the region.

There are still areas where there are problems. One area, for example, is in land registration, which is not reliable, and without proper land registration, it's hard to use land as collateral, it's hard to buy or sell property. So there are things like that that still require a lot of further work, but, nonetheless, attention has been paid to all of these issues.

Areas where there's been relatively limited progress so far are areas like the reform of the local government. The provision of local government services has been severely affected by the lack of resources available to local government. That is partly related to the effect of the conflict, but also it reflects a need for the reform of local government and a reorganization of local government finance. And related to this is also a need to have an elected local government. Therefore, there needs to be elections at some point for local government.

There also needs to be elections at the national level, for which a comprehensive voter registration needs to be undertaken, and that obviously has been held up by all of the closures and the checkpoints, which prevent the officers from going out and gathering the information necessary to establish such a register.

Another area where there has been good progress lately is in judicial reform. The state security courts, which had long been criticized as a forum for arbitrary justice, have now been abolished, and the judicial system is now headed by an independent Supreme Judicial Council.

So there are diverse areas of reform, some of which have progressed extremely well, and some of which have progressed quite slowly. But, anyway, they're all discussed at some length in this study....

Source: IMF