## 1wbgea2022001

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---

### Rising wage bill pressures
- Key findings:
  - The public sector wage bill in West Bank and Gaza was 12.9 percent of GDP at end-2020 and is estimated to have increased to 13.6 percent of GDP in 2021.
  - The wage bill accounts for 44 percent of total expenditure, compared to 36 percent in peer countries.
  - The wage bill absorbs 53 percent of revenues (including grants), compared to 36 percent in peer countries.
  - The wage bill rose by 13.2 percent in 2021, largely driven by the reinstatement of full salaries for 6,000 Gaza employees of the Palestinian Authority (PA).
  - The reinstatement of full salaries for these Gaza employees is estimated to cost $200 million annually, equivalent to 1.1 percent of GDP.
- Drivers of the 2021 increase:
  - Reinstatement of full salaries for 6,000 Gaza employees who previously received 70 percent of their salaries.
  - Pandemic-related fiscal pressures and emergency policy responses that increased overall spending.
- Fiscal implications and risks:
  - Sustaining a wage bill at 13.6 percent of GDP presents a significant fiscal challenge given rising deficits, falling grants, and increasing public debt and arrears.
  - High wage spending as a share of revenues and expenditure constrains fiscal space for other priorities and exacerbates the accumulation of domestic arrears and debt dynamics.
- Reform options and potential fiscal savings:
  - A wage freeze for the bottom 50 percent of PA staff to reduce their pay gap relative to the private sector would save 1.9 percent of GDP after five years.
  - Net zero staff growth in the civil service outside health and education would reduce the wage bill by 0.5 percent of GDP.
  - Reducing the number of higher ranks in the security sector would reduce the wage bill by 3 percent of GDP.

### Arrears, immediate economic effects, and risks
- Risks from PA arrears and immediate economic effects:
  - Government suppliers that do not get paid are likely to be unable to pay their own suppliers and lenders, leading to cascading arrears, lack of liquidity, and a possible uptick in NPLs.
  - Some suppliers have provided their claims on government as collateral to banks or sold them outright at less than face value, improving liquidity but depressing profitability.
  - Government contractors may raise prices to account for likely payment delays, increasing costs to government for goods and services.
- Additional risk factors:
  - Unemployment, poverty, frustration with the lack of progress on the peace process and dissatisfaction with domestic politics may lead to escalation of civil unrest or another confrontation with Israel.
  - Further food, fuel and building material price increases and volatility due to the Russian invasion of Ukraine.
  - A resurgence of the COVID pandemic could harm trade, investment, and consumer spending.
  - Given the fiscal outlook, the PA would have little room to support the economy, while the PMA’s ability to provide monetary stimulus is limited.
- Growth prospects and projections:
  - Economy grew at an estimated 6 percent last year.
  - Projected growth of 4 percent this year.
  - Medium-term growth projected to gradually decrease to its long-term potential rate of 2 percent.
  - Projected population growth exceeds projected GDP growth, implying decreasing real per capita GDP.
  - Inflation is projected to increase due to increased commodity prices and inflationary pressures in Israel, but remain contained.

### Resolving the fiscal crisis — overall strategy and priorities
- Objective and approach:
  - Objective: first arrest the increase in public debt (which includes arrears) and subsequently bring it down, including through the clearance of arrears.
  - Time horizon: multi-year given the size of the fiscal deficit and the multitude of difficult reforms.
  - Analytical tool: a comprehensive medium-term macro-fiscal framework (MTFF) to analyze tradeoffs and assess medium-term effects of reforms.
- Key PA policy priorities and fiscal measures:
  - Contain and rebalance public spending while boosting growth.
  - Systematic reform of non-discretionary spending: civil service salaries and benefits; transfer payments; public pension scheme; health care system; fuel subsidies (0.4 percent of GDP in 2021).
  - Improve quality of expenditure by shifting more resources to development spending and improving the social safety net.
  - Revenue measures: scope to enhance revenue through base broadening, revisiting tax rates, streamlining exemptions, and modest tax administration gains.

### Expenditure, PFM, and public investment reforms
- Expenditure reforms — key elements:
  - Tackle the wage bill as a priority; authorities intend a net hiring freeze and are working with the World Bank on options to contain the wage bill.
  - Civil service reform may include grade restructuring, integration of most allowances into base pay, and gradual reduction of public sector staff in targeted categories.
  - Health system reforms (e.g., health referrals) to reduce overuse and improve cost recovery.
  - Streamlining transfers to the pension fund would require comprehensive pension system reform.
  - Reform net lending setup, reorganize fiscal relations between the PA and municipalities and Israeli cooperation.
  - Phase out general subsidies while increasing benefit levels and coverage of the existing cash transfer program and expanding cash-for-work schemes.
    - Cash transfer program covers 115,000 households, providing quarterly transfers between NIS 750-1,800 (USD 232-557). Some 80 percent of beneficiaries are extreme poor, and 87 percent of transfer goes to poverty gap reduction.
- PFM enhancements and recommended actions:
  - Set multi-year expenditure ceilings.
  - Strengthen fiscal accounting and reporting.
  - Undertake comprehensive stock taking of arrears and adopt a strategy for gradual clearance based on clear and transparent criteria (including cash payment and securitization).
  - Improve timeliness of audit of financial accounts.
- Public investment and development spending:
  - Policy package should increase development spending to boost long-term growth potential and create fiscal space for productive public investment.
  - Emphasis on prioritization of the most productive public investment and timely, cost-effective project implementation.

### Financial sector, correspondent banking, and soundness measures
- Financial sector policies and recommendations:
  - PMA should continue to scrutinize financial sector risks and leverage IMF TA that strengthened stress testing capabilities.
  - Work with banks to strengthen buffers and bolster bank resolution and crisis management toolkit.
  - Macroprudential: enforce concentration limits and consider new tools such as leverage ratios.
- Correspondent banking relations (CBRs) and AML/CFT:
  - Shekel CBRs rely on renewal of letters of immunity and indemnity issued by the GoI.
  - Completed ML/TF National Risk Assessment and upcoming MENAFATF AML/CFT evaluation could reduce pressure on CBRs.
  - Strengthen cross-border payments infrastructure and consider longer-term mechanisms to partially replace existing CBRs.

### Need for Palestinian-Israeli cooperation and donor support
- Cooperative measures recommended with Israel:
  - Broaden e-VAT pilot to all commerce between Israeli and Palestinian markets.
  - Redesign the net lending system by which the GoI withholds funds to cover overdue amounts to commercial Israeli utility providers.
  - Address the split of Allenby bridge exit fees and set up inspection modalities for customs transfers.
  - Reduce the 3 percent administrative handling fee on imports; consider exempting fuel imports from excise tax and VAT instead of charging and refunding and subjecting refunds to the 3 percent fee.
  - Cooperate to properly tax economic activity in Area C and relay proceeds to the PA.
  - Movement and access issues can only be resolved in agreement with Israel; easing restrictions and improving access to Area C would support development and private-sector-led growth.
- Donor support:
  - An increase in donor grants would facilitate reform, reduce adverse impact of fiscal consolidation, finance development projects, and decrease arrears financing.
  - Donor support assumed to gradually increase by 1 percent of GDP relative to the baseline in the reform scenario.

### Illustrative reform scenario and numeric assumptions
- Objective: turn around adverse debt dynamics through a total fiscal turn-around of just over 4 percent of 2022 GDP over the three-year period 2022–24.
- Assumptions:
  - Resolution of most major fiscal leakages issues with Israel within three years.
  - Gradual implementation of major expenditure and revenue reforms yielding just under 2 percent of GDP on a net basis over three years.
  - Gross adjustment envisaged is almost 4 percent of GDP to create space for an additional 2 percent of GDP in development spending by 2024.
  - Donor support assumed to gradually increase by 1 percent of GDP relative to the baseline.
- Fiscal adjustment breakdown (as presented):
  - Palestinian Authority 3.863 (Percent of GDP / Percent of Total)
  - Revenue measures 0.6
  - Expenditure measures 3.2
  - Israel-PA agreement on Fiscal Leakages 1.321
  - Donor support 1.016
  - Memorandum items:
    - Higher development spending -2.0
    - Net fiscal adjustment by the PA 1.8
- Growth effects:
  - The economy’s growth rate would gradually increase to 6 percent under the scenario.
- Caveats:
  - The scenario does not include reunification between the West Bank and Gaza.
  - The scenario does not assume any tax revenue from Area C.

### Debt sustainability, stress tests, and headline DSA findings
- Headline finding:
  - With unchanged policies debt will rise from 34.5 percent of GDP pre-COVID to about 65 percent of GDP by 2027.
- Structure and composition notes:
  - At end-2021, gross public debt was estimated at 49.3 percent of GDP compared to 34.5 percent of GDP in 2019.
  - Domestic debt (including arrears) represented 85 percent of total debt at end-2021, with arrears the largest component.
  - External debt represented 15 percent of total debt at end-2021; some 86 percent of foreign debt is long term.
  - Biggest external creditors: the Al Aqsa Fund (39 percent of external debt), World Bank (about 20 percent), and the Qatar National Bank (about 20 percent). Bilateral creditors (Italy, Spain) account for about 12 percent of external debt.
- Baseline DSA projections (selected exact figures):
  - Nominal gross public debt: 50.7 (2022), 53.0 (2023), 55.8 (2024), 58.8 (2025), 61.8 (2026), 64.8 (2027) [percent of GDP]
  - Public gross financing needs: 7.5 (2022), 17.2 (2023), 17.0 (2024), 18.4 (2025), 16.0 (2026), 20.7 (2027) [percent of GDP]
  - Real GDP growth: 6.0 (2021), 4.0 (2022), 3.5 (2023), 2.4 (2024), 2.0 (2025), 2.0 (2026), 2.0 (2027) [percent]
  - Primary deficit (percent of GDP): 7.4 (2021), 4.6 (2022), 3.8 (2023), 4.3 (2024), 4.4 (2025), 4.6 (2026), 4.4 (2027)
  - Change in gross public sector debt (cumulative, 2022-27): 15.6 (percent of GDP)
  - Identified debt-creating flows (cumulative, 2022-27): 15.5 (percent of GDP)
- Stress scenarios (selected outcomes):
  - Growth shock: public debt would reach 78 percent of GDP by 2027.
  - Combined macro-fiscal shock (growth shock + temporary fiscal deterioration): public debt would exceed 85 percent of GDP by 2027.
  - Contingent liability shock (one-time upfront increase in debt with penalties/interest): debt would reach about 80 percent of GDP by 2027.
  - Political unrest shock: temporary but sizable shock can lead to a sharp deterioration in deficits and debt beyond authorities’ capacity to manage.

### Financial soundness indicators (selected, exact figures)
- Capital adequacy:
  - Tier I capital to risk-weighted assets: Dec-20 13.9; Dec-21 14.3.
  - Regulatory capital to risk-weighted assets: Dec-20 15.7; Dec-21 16.1.
- Asset quality:
  - Nonperforming loans (percent of total loans): Dec-20 4.2; Dec-21 4.2.
  - Coverage ratio (provisions as percent of nonperforming loans): Dec-20 86.1; Dec-21 94.4.
- Earnings and profitability:
  - Return on assets (ROA): Dec-21 1.2.
  - Return on equity (ROE): Dec-21 15.1.
- Liquidity:
  - Liquid assets to total assets: Dec-20 33.2; Dec-21 33.2.
  - Liquid assets to total deposits: Dec-20 42.1; Dec-21 42.0.
  - Liquid assets to short-term liabilities: Dec-20 47.5; Dec-21 47.2.

### Key macroeconomic and fiscal projections (selected exact figures)
- Per capita GDP: $3,045; 2020 est.
- Real GDP (2015 market prices) projections (annual percentage change):
  - 2019: 1.4; 2020: -11.3; 2021: 6.0; 2022: 4.0; 2023: 3.5; 2024: 2.4; 2025: 2.0; 2026: 2.0; 2027: 2.0.
- Unemployment rate (period average):
  - 2019: 25.4; 2020: 25.9; 2021: 26.4; 2022: 25.7; 2023: 25.0; 2024: 24.5; 2025: 24.2; 2026: 24.1; 2027: 24.0.
- CPI inflation rate (end-of-period):
  - 2019: 1.3; 2020: 0.1; 2021: 1.3; 2022: 2.6; 2023: 2.3; 2024: 2.3; 2025: 2.2; 2026: 2.3; 2027: 2.0.
- Nominal GDP (in millions of U.S. dollars):
  - 2019: 17,134; 2020: 15,532; 2021: 16,679; 2022: 17,847; 2023: 18,925; 2024: 19,837; 2025: 20,706; 2026: 21,613; 2027: 22,499.
- Central government fiscal operations (selected):
  - Revenue and grants (percent of GDP): 2019: 23.1; 2020: 25.1; 2021: 25.7; 2022: 26.3; 2023: 25.5; 2024: 25.5; 2025: 25.5; 2026: 25.5; 2027: 25.5.
  - Wages and salaries (percent of GDP): 2019: 10.9; 2020: 12.9; 2021: 13.6; 2022: 13.7; 2023: 13.7; 2024: 13.8; 2025: 13.9; 2026: 14.1; 2027: 14.2.
  - Development expenditures (percent of GDP): 2.0 (2019), 1.8 (2020), 1.4 (2021–2027).
  - Overall balance (commitment, before external support) (percent of GDP): 2019: -7.3; 2020: -10.7; 2021: -7.1; 2022: -6.6; 2023: -6.4; 2024: -6.5; 2025: -6.7; 2026: -6.7; 2027: -6.8.
  - Central government debt (incl. arrears) (percent of GDP): 2019: 34.5; 2020: 47.3; 2021: 49.3; 2022: 50.5; 2023: 52.7; 2024: 55.5; 2025: 58.6; 2026: 61.6; 2027: 64.8.

### Growth under reform scenarios (methodology and outcomes)
- Illustrative policy package modeled:
  - Easing and speeding licensing, improving insolvency regime, strengthening protection of minority investors.
  - Steady easing of restrictions on movement of goods and services between West Bank and Gaza and Israel; expanding A1/A2/B goods lists and curtailing the dual use list; allowing free movement of agricultural and industrial goods.
  - Smoothing customs clearance and inspection; allowing higher labor mobility.
  - Improved access to land and water in Area C and elimination of constraints to Palestinian investment in the area.
- Methodology:
  - Production function Yt = At Ktα Lt1- α with α set at 0.33.
  - Capital stocks via perpetual inventory method with initial capital-output ratio of 3.
  - Annual depreciation rate set at 3 percent plus 5 percent additional depreciation during years of conflict (specific applications noted).
  - Impact of reforms on labor, capital, and TFP anchored on a 2017 World Bank study; reforms added sequentially.
- Main quantitative assumptions and scenario outcomes:
  - Investment to GDP ratio rises from 24.5 percent in 2017–20 to 32 percent under reforms.
  - Baseline average investment over 2023–27 is 23 percent.
  - Labor’s contribution to growth increases by 0.3 percentage points to 2.5 percentage points on average under reforms, compared to 2.2 percent points under the baseline.
  - TFP growth assumed to increase to 0.5 percent per year compared to its 20-year average of 0.1 percent.
  - Aggregate growth: overall reforms would gradually increase the economy’s growth rate to 6 percent.
- Caveats and exclusions:
  - Analysis not conducted separately for West Bank and Gaza.
  - Impact of lifting Gaza blockade or reunification not considered.
  - Scenarios do not assume any tax revenue from Area C.

### Staff appraisal — risks and policy priorities (summary)
- Current assessment:
  - Palestinian economy is recovering from the depth of the 2020 recession, but the fiscal outlook is dire.
  - Despite good revenue performance in 2021, COVID-19, declining donor support, and spending priorities resulted in high deficits and large domestic arrears.
  - Fiscal challenges are largely structural; without policy change, debt is on an unsustainable path and per capita GDP is projected to decline over the medium term.
- Main risks:
  - Continued reliance on running arrears could lead to lack of private sector liquidity and harm growth.
  - Banking sector exposure to the PA could transmit fiscal stress to banks.
  - Possible disruption to shekel correspondent banking relations.
  - Political, security and socioeconomic instability could cause renewed unrest affecting the economy.
  - COVID pandemic flare ups could lower activity and worsen PA finances.
- Recommended path:
  - Transformational reform involving the PA, Israel, and donors.
  - Develop a medium-term macro-fiscal strategy consistent with debt sustainability.
  - PA should implement spending reforms centered on the wage bill, health referrals, pension transfers and net lending; broaden the tax base; and undertake structural reform to improve the business environment.
  - Israeli and Palestinian authorities should resolve fiscal leakages and reduce impediments to movement of goods and people.
  - Boosting confidence through reform implementation could attract donor funds to ease the transition burden.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### 1.    Rising    Wage    Bill Pressures _____________________________________________________________________8

### 1.    Rising    Wage    Bill Pressures

### Key findings
- The public sector wage bill in West Bank and Gaza was 12.9 percent of GDP at end-2020 and is estimated to have increased to 13.6 percent of GDP in 2021.
- The wage bill accounts for 44 percent of total expenditure, compared to 36 percent in peer countries.
- The wage bill absorbs 53 percent of revenues (including grants), compared to 36 percent in peer countries.
- The wage bill rose by 13.2 percent in 2021, largely driven by the reinstatement of full salaries for 6,000 Gaza employees of the Palestinian Authority (PA).
- The reinstatement of full salaries for these Gaza employees is estimated to cost $200 million annually, equivalent to 1.1 percent of GDP.

### Drivers of the 2021 increase
- Reinstatement of full salaries for 6,000 Gaza employees who previously received 70 percent of their salaries.
- Pandemic-related fiscal pressures and emergency policy responses that increased overall spending (context provided in adjacent text).

### Fiscal implications and risks
- Sustaining a wage bill at 13.6 percent of GDP presents a significant fiscal challenge given the broader fiscal crisis described (rising deficits, falling grants, and increasing public debt and arrears in the broader chapter).
- High wage spending as a share of revenues and expenditure constrains fiscal space for other priorities and exacerbates the accumulation of domestic arrears and debt dynamics.

### Reform options and potential fiscal savings (as presented)
- A wage freeze for the bottom 50 percent of PA staff to reduce their pay gap relative to the private sector would save 1.9 percent of GDP after five years.
- Net zero staff growth in the civil service outside health and education would reduce the wage bill by 0.5 percent of GDP.
- Reducing the number of higher ranks in the security sector would reduce the wage bill by 3 percent of GDP.

### Analysis summary
- The wage bill is high by regional standards and concentrated in key budgetary categories, amplifying fiscal vulnerability.
- Targeted personnel and pay reforms, as outlined, could deliver sizable savings (1.9 percent, 0.5 percent, and 3 percent of GDP from the respective measures above), which would help address structural fiscal pressures if implemented alongside broader fiscal reforms.

*Source: IMF — West Bank and Gaza, Box 1. Rising Wage Bill Pressures (extracted content).*

### 12.      The increasing stock of PA arrears is also bound to present risks to the real economy.

### 12.      The increasing stock of PA arrears is also bound to present risks to the real economy.

### Risks from PA arrears and immediate economic effects
- Government suppliers that do not get paid are likely to be unable to pay their own suppliers and lenders, leading to cascading arrears and lack of liquidity in the economy, and a possible uptick in NPLs.
- Some suppliers have provided their claims on government as collateral to banks or sold them outright at less than face value, improving their liquidity but depressing profitability.
- Government contractors may raise prices to account for the likelihood of payment delays, thus increasing the costs to government for goods and service.

### Additional risk factors (political, pandemic, war in Ukraine)
- Unemployment, poverty, frustration with the lack of progress on the peace process and dissatisfaction with domestic politics may lead to escalation of civil unrest or another confrontation with Israel.
- Further food, fuel and building material price increases and volatility going forward due to the Russian invasion of Ukraine add to these risks.
- A resurgence of the COVID pandemic, associated with mandatory or voluntary restriction of economic activity, could harm trade and investment, as well as consumer spending.
- Given the fiscal outlook, the PA would have little room to support the economy, while the PMA’s ability to provide monetary stimulus is also limited.
- The fragile political and social environment may lead to inadequate policy response to the current challenges.

### Growth prospects and projections
- Recent and projected growth:
  - Economy grew at an estimated 6 percent last year.
  - Projected growth of 4 percent this year.
  - Medium-term growth projected to gradually decrease to its long-term potential rate of 2 percent.
- Drivers and constraints:
  - Restrictions on the movement of goods and people (including access to Area C), weak labor market outcomes, and low public and private investment constrain growth.
  - Projected population growth exceeds projected GDP growth, implying decreasing real per capita GDP.
  - Inflation is projected to increase due to increased commodity prices and inflationary pressures in Israel, but remain contained.

### Resolving the fiscal crisis — overall strategy
- Objective: first arrest the increase in public debt (which includes arrears) and subsequently bring it down, including through the clearance of arrears.
- Time horizon: multi-year given the size of the fiscal deficit and the multitude of difficult reforms.
- Analytical tool: a comprehensive medium-term macro-fiscal framework (MTFF) to analyze tradeoffs (e.g., tightening fiscal stance vs easing movement restrictions) and to assess medium-term effects of reforms.

### Key PA policy priorities and fiscal measures
- Contain and rebalance public spending while boosting growth.
- Systematic reform of key drivers of non-discretionary spending:
  - Civil service salaries and benefits.
  - Transfer payments.
  - Public pension scheme.
  - Health care system.
  - Fuel subsidies (noted as comprising 0.4 percent of GDP in 2021).
- Improve quality of expenditure by shifting more resources to development spending and improving the social safety net.
- Revenue measures: scope to enhance revenue through base broadening (reducing tax evasion and informality), revisiting tax rates, streamlining exemptions, and modest tax administration gains.

### Expenditure reforms — key elements
- Tackle the wage bill as a priority; authorities intend a net hiring freeze and are working with the World Bank on options to contain the wage bill.
- Comprehensive civil service reform may include grade restructuring, integration of most allowances into base pay, and gradual reduction of public sector staff in targeted categories.
- Health system reforms (e.g., health referrals) to reduce overuse and improve cost recovery; more comprehensive health reform may be required.
- Streamlining transfers to the pension fund would require comprehensive pension system reform.
- Net lending setup is not transparent; reform needed including reorganization of fiscal relations between the PA and municipalities and Israeli cooperation.
- Phasing out general subsidies while increasing benefit levels and coverage of the existing cash transfer program and expanding cash-for-work schemes could yield savings.
  - Cash transfer program currently covers 115,000 households, providing quarterly transfers between NIS 750-1,800 (USD 232-557). Some 80 percent of beneficiaries are extreme poor, and 87 percent of transfer goes to poverty gap reduction.

### Public investment and development spending
- Policy package should increase development spending to boost long-term growth potential and create fiscal space for productive public investment.
- Emphasis on prioritization of the most productive public investment and timely, cost-effective project implementation.

### Public financial management (PFM) enhancements
- PEFA (2018) findings: good budget classification, guidance on budget preparation, and cash forecasting and monitoring; weaknesses on budget calendar, expenditure ceilings, and commitment controls.
- Recommended actions:
  - Set multi-year expenditure ceilings.
  - Strengthen fiscal accounting and reporting.
  - Undertake comprehensive stock taking of arrears and adopt a strategy for gradual clearance based on clear and transparent criteria (including cash payment and securitization).
  - Improve timeliness of audit of financial accounts.

### Financial sector policies and correspondent banking
- PMA should continue to scrutinize financial sector risks and leverage IMF TA that strengthened stress testing capabilities.
- Work with banks to strengthen buffers and bolster bank resolution and crisis management toolkit (building on IMF TA).
- Macroprudential: enforce concentration limits and consider new tools such as leverage ratios.
- Address uncertainty around correspondent banking relations (CBRs) between Israeli and Palestinian banks:
  - Shekel CBRs rely on renewal of letters of immunity and indemnity issued by the GoI.
  - Completed ML/TF National Risk Assessment and upcoming MENAFATF AML/CFT evaluation for WBG, and subsequent follow-up, could reduce pressure on CBRs.
  - Strengthen cross-border payments infrastructure and consider longer-term mechanisms to partially replace existing CBRs.

### Structural reforms to improve business environment and utilities
- Reforms within PA control to revitalize private sector:
  - Faster and easier business registration and licensing.
  - Improvements to the insolvency regime.
  - Stronger protection of minority investors.
  - Finalize legislation on debt settlement, competition, and consumer protection; pursue improvements to telecom law.
- Address reliability and affordability of electricity and water supply—priority for Gaza and West Bank.
- Increase vocational training to bridge labor market skill gaps.

### Need for Palestinian-Israeli cooperation and donor support
- Collaboration required to reduce fiscal leakages and make systemic changes beyond one-off payments, including transparent information exchange on amounts withheld.
- Cooperative measures recommended:
  - Broaden e-VAT pilot to all commerce between Israeli and Palestinian markets.
  - Redesign the net lending system by which the GoI withholds funds to cover overdue amounts to commercial Israeli utility providers.
  - Address the split of Allenby bridge exit fees and set up inspection modalities for customs transfers.
  - Reduce the 3 percent administrative handling fee on imports; consider exempting fuel imports from excise tax and VAT instead of charging and refunding and subjecting refunds to the 3 percent fee.
  - Cooperate to properly tax economic activity in Area C and relay proceeds to the PA.
- Movement and access issues can only be resolved in agreement with Israel; easing restrictions and improving access to Area C would support development and private-sector-led growth.
- Donor support:
  - An increase in donor grants would facilitate reform, reduce adverse impact of fiscal consolidation, finance development projects, and decrease arrears financing.
  - Donor support assumed to gradually increase by 1 percent of GDP relative to the baseline in the reform scenario.

### Illustrative reform scenario and numeric assumptions
- Objective: turn around adverse debt dynamics through a total fiscal turn-around of just over 4 percent of 2022 GDP over the three-year period 2022–24.
- Assumptions:
  - Resolution of most major fiscal leakages issues with Israel within three years.
  - Gradual implementation of major expenditure and revenue reforms yielding just under 2 percent of GDP on a net basis over three years.
  - Gross adjustment envisaged is almost 4 percent of GDP to create space for an additional 2 percent of GDP in development spending by 2024.
  - Donor support assumed to gradually increase by 1 percent of GDP relative to the baseline.
- Fiscal adjustment breakdown (as presented):
  - Palestinian Authority 3.863 (Percent of GDP / Percent of Total)
  - Revenue measures 0.6
  - Expenditure measures 3.2
  - Israel-PA agreement on Fiscal Leakages 1.321
  - Donor support 1.016
  - Memorandum items:
    - Higher development spending -2.0
    - Net fiscal adjustment by the PA 1.8
- Growth effects:
  - Structural measures, easing movement restrictions, improved access to Area C, increased private investment and public development spending are assumed to strengthen established sectors and unleash potential in sectors such as Dead Sea tourism, information and communication technologies, and potash and bromine mining.
  - The economy’s growth rate would gradually increase to 6 percent under the scenario.
- Caveats:
  - The scenario does not include reunification between the West Bank and Gaza.
  - The scenario does not assume any tax revenue from Area C.

### Fiscal adjustment in context of IMF program experience (Box 2)
- Average targeted improvement in the fiscal balance in countries with an IMF-supported program over the last five years was 2.4 percent of GDP over three years.
- The PA gross fiscal effort proposed in the reform scenario is 3.8 percent of GDP, placing it at the 75th percentile of this distribution.
- IMF program experience:
  - Fiscal adjustment typically achieved mainly through spending cuts focused on improving efficiency (reducing subsidy and wage bill spending) to free resources for growth-enhancing public investment.
  - Revenue measures typically focused on broadening the tax base, reducing distortions, and improving revenue administration.
  - Longer period of engagement and increased donor support are often required to achieve results; donor grants and external support can smooth the transition.

*WEST BANK AND GAZA, INTERNATIONAL MONETARY FUND*

### 29.      Taken together, these policies would allow turning the fiscal corner and making a

### Taken together, these policies would allow turning the fiscal corner and making a start on reducing debt

### Fiscal outlook and debt dynamics
- Policies described would allow slowing accumulation of debt (including arrears) during 2022–23 and make a start with reducing debt in 2024.
- Clearing arrears through cash payments and reducing debt more broadly would create space for new policy priorities beyond 2024.
- Debt in 2027 would return to below its level in 2020.
- Continuing reform efforts beyond 2024 or increased donors support would help bring debt down faster, shortening the period until debt comes down to a long-term sustainable level.
- Confirmation that the stock of arrears is lower than currently estimated or agreement between the PA and Israel on relaying part of the accumulated stock of past fiscal leakages and the prisoner payment deductions would improve outcomes.
- Under a partial reform scenario (PA reforms without Israel and donor support), debt including arrears would climb to 56 percent of GDP by the end of the projection horizon in 2027 and continue increasing afterwards, with a large part of the increase presumably in the form of arrears.

### Growth scenarios and drivers
- Full reform scenario:
  - Growth would reach 6 percent in 2027 under the reform scenario laid out (¶27–28).
  - Adoption and implementation of new legislation easing and speeding licensing, improving the insolvency regime, and strengthening protection of minority investors would boost private investment, including foreign direct investment.
  - Steady easing of restrictions on movement of goods and services between the West Bank and Israel (expanding the lists of A1/A2/B goods; curtailing the dual use list; allowing free movement of agricultural and industrial goods; smoothing customs clearance and inspection; allowing higher labor mobility) would raise total factor productivity.
  - Improved access to land and water in Area C, elimination of constraints to Palestinian investment in the area, and lower transportation costs (with less checkpoints and use of all roads) would raise both capital and total factor productivity.
  - Labor effects are smaller as many Palestinians are expected to start to work in Israel and settlements, where wages are higher than in the Palestinian private sector.
  - These measures are assumed to increase private investment, in part financed through higher capital inflows.
  - Increased public development spending (¶27) combined with the above would gradually increase the economy’s growth rate to 6 percent.
- Partial reform scenario:
  - Growth would reach 3½ percent under a partial reform scenario that includes only PA reforms to improve the business environment.
  - Illustrates that the main contribution to increasing growth would come from easing of Israeli restrictions.
- Growth composition 2022–27:
  - Main drivers would be capital and labor, with modest contributions from total factor productivity (TFP).
  - Employment and capital contribute more than during 2017–20, with capital productivity unleashed as domestic private sector growth and access to financing for investment from abroad improves.
  - TFP growth is assumed to increase compared to recent years, but remain well-below the 2006–14 high-growth period.

### Authorities’ views and planned measures
- Authorities concur with the need to shift attention to medium-term fiscal policy to elaborate reform priorities and move away from short-term liquidity management, while noting assumptions will change given risks and uncertainties and political economy constraints (particularly limited authority in Gaza).
- Spending reforms and constraints:
  - Authorities consider options to reduce spending, prioritize tackling risks from a rising wage bill that absorbs a significant part of the PA’s revenues.
  - Highlight substantial allotments for wages and benefits in the security sector and to civil servants in Gaza; cutting these would be politically difficult.
  - Intend to continue to pay less than full salaries to civil servants, pending deeper wage reform.
  - On health reform, authorities agree on need to control costs related to referrals through a clear and transparent decision-making mechanism but cite capacity constraints in the public health care system making referrals to Israeli or private Palestinian providers indispensable in the short term; lack funds to invest in public system presently.
  - Reforming fiscal relationship between the PA and municipalities to address inability to pay Israeli utility suppliers would take time and require cooperation from Israel; many local governments would continue to rely on central government support, limiting fiscal savings potential from net lending reform.
  - To counter spiking wheat prices due to the war in Ukraine, authorities announced temporary VAT exemptions on flour and bread, expected to have limited budgetary impact.
- Revenue measures and fiscal leakages:
  - Authorities note very strong 2021 revenue performance and aim to boost it further via tax administration efforts (soon to be adopted revenue strategy) and reduced smuggling related to lockdowns and movement restrictions.
  - To reduce tax evasion, they plan to improve exchange of information between banks and the tax authority.
  - The e-VAT system, which started in March 2022, is expected to increase efficiency and make tax evasion harder by reducing scope for under-declaring value of imports and reducing compliance costs for companies.
  - Authorities expect an annual gain in revenues of 0.9 percent of GDP from the e-VAT, provided remaining hurdles linking the Palestinian and Israeli systems in real time can be resolved soon.
  - Authorities are keen to work with Israel to resolve fiscal leakages (handling fee for customs administration, Allenby bridge exit fees, excise and VAT on fuel imports, tax revenue from Area C activity, customs transfers); most would be resolved if Israel abided by the provisions of the Paris Protocol.
- Arrears strategy:
  - Over time, implementing policies would allow for gradual repayment of arrears.
  - Authorities view arrears clearance as essential to ensure debt sustainability and aim to first reduce and then cease reliance on arrears financing, followed by bringing down the nominal stock of outstanding amounts to suppliers.
  - Part of liquidity improvement from reduced civil servant salary payments in late 2021 and early 2022 was used to repay old arrears.
  - Authorities indicate arrears to the pension fund should be assessed differently because associated obligations come due far into the future; they see no immediate real economic consequences as long as current pension entitlements continue to be paid.
  - Arrears clearance is seen as important to create fiscal space for future development and social expenditure.
- Financial sector policies:
  - Authorities see the MENAFATF AML/CFT onsite evaluation planned for August this year as important to maintaining shekel CBRs.
  - Working with the Bank of Israel to establish publicly-owned correspondent companies to take over large parts of the CBR functions; progress is slow.
  - Ongoing IMF assistance to evaluate options to strengthen domestic and cross-border payments infrastructure.
  - PMA has maintained the capital surcharge on systemically important domestic banks throughout the pandemic and requires banks to rebuild their countercyclical capital buffers by end 2023.
  - Plans to use multi-factor stress testing to inform supervisory dialogue, discuss credit concentration limits, and review bank resolution and crisis management frameworks.
  - Progress in promoting financial inclusion and development, encouraging e-wallet adoption and increased use of e-payments during the pandemic.
  - Planned improvements to the credit and moveable asset registries expected to facilitate bank lending to the traditionally unbanked.
  - Israeli initiatives to require electronic payment of Palestinian workers who hold permits to work in Israel are expected to help alleviate banks’ excess cash problems.
- Business environment and electricity:
  - Recent adoption of the companies law facilitates electronic business registration and removed minimum starting capital requirement.
  - Drafting a new competition law, working on a new law facilitating vocational training, and established a task force on intellectual property protection.
  - To alleviate electricity bottlenecks, authorities focus on investment in renewable energy and programs to increase lending capacity of local banks for private sector green energy projects.
  - Together with Israel, pursuing construction of a new gas pipeline that would link Gaza to the existing Israeli network, potentially providing gas-fired power and significantly reducing Gaza’s electricity shortages in the medium term.

### Staff appraisal — risks and policy priorities
- Current assessment:
  - Palestinian economy is recovering from the depth of the 2020 recession, but the fiscal outlook is dire.
  - Despite a good revenue performance in 2021, COVID-19, declining donor support, and spending priorities resulted in high deficits and large domestic arrears.
  - Fiscal challenges are largely structural; without policy change, outlook is dire with debt on an unsustainable path and per capita GDP projected to decline over the medium term.
- Risks:
  - Primary risks relate to the PA’s fiscal situation: under unchanged policies, continued reliance on running arrears could lead to lack of private sector liquidity and harm growth.
  - Banking sector has large direct and indirect exposure to the PA, so PA fiscal challenges could affect banks.
  - Possible disruption to shekel correspondent banking relations.
  - Political, security and socioeconomic instability could cause renewed unrest directly affecting the economy.
  - A COVID pandemic flare up could lower activity and worsen PA finances.
- Recommended path:
  - Lasting improvements depend on transformational reform involving the PA, Israel, and donors.
  - Develop a medium-term macro-fiscal strategy that allows government investment in development and social spending while being consistent with debt sustainability.
  - PA should implement spending reforms centered on the wage bill, health referrals, pension transfers and net lending; further broaden the tax base; and undertake structural reform to improve the business environment.
  - Israeli and Palestinian authorities should resolve fiscal leakages to boost revenue and reduce impediments to movement of goods and people to unleash growth potential.
  - Boosting confidence through reform implementation could attract donor funds to ease the transition burden on population and private sector.
  - A comprehensive joint effort would strengthen macroeconomic stability and pave the way for faster economic growth, job creation and poverty alleviation.

*Source: IMF staff calculations and staff appraisal as presented in the supplied text.*

### 40.      The PMA should continue to scrutinize financial sector risks closely to contain

### 1wbgea2022001 - 40.      The PMA should continue to scrutinize financial sector risks closely to contain

### Financial sector risks and policy recommendations
- The PMA should continue to scrutinize financial sector risks closely to contain potential vulnerabilities.
- Monitoring priorities:
  - Banks’ exposure to the PA.
  - Loan provisioning.
  - Private sector credit concentration.
- Regulatory actions:
  - Sharpen requirements where deemed necessary.
- AML/CFT:
  - Continued efforts to strengthen the AML/CFT regime will remain crucial, both in the runup to and after the MENAFATF onsite evaluation later this year.
  - Strong AML/CFT policies and ongoing work to strengthen cross-border payment infrastructure can alleviate risks currently surrounding shekel CBRs and help reduce banks’ excess liquidity.

### Key macroeconomic projections and indicators (selected)
- Per capita GDP: $3,045; 2020 est.
- Poverty rate: 14 percent in the West Bank and 53 percent in Gaza Strip; 2017 est.
- Real GDP (2015 market prices) projections (annual percentage change):
  - 2019: 1.4
  - 2020: -11.3
  - 2021: 6.0
  - 2022: 4.0
  - 2023: 3.5
  - 2024: 2.4
  - 2025: 2.0
  - 2026: 2.0
  - 2027: 2.0
- Unemployment rate (period average):
  - 2019: 25.4
  - 2020: 25.9
  - 2021: 26.4
  - 2022: 25.7
  - 2023: 25.0
  - 2024: 24.5
  - 2025: 24.2
  - 2026: 24.1
  - 2027: 24.0
- CPI inflation rate (end-of-period):
  - 2019: 1.3
  - 2020: 0.1
  - 2021: 1.3
  - 2022: 2.6
  - 2023: 2.3
  - 2024: 2.3
  - 2025: 2.2
  - 2026: 2.3
  - 2027: 2.0
- Gross capital formation (percent of GDP):
  - 2019: 26.8
  - 2020: 24.3
  - 2021: 26.1
  - 2022: 28.8
  - 2023: 28.1
  - 2024: 27.2
  - 2025: 26.5
  - 2026: 25.7
  - 2027: 25.0
- Gross national savings (percent of GDP):
  - 2019: 16.4
  - 2020: 12.1
  - 2021: 12.6
  - 2022: 14.7
  - 2023: 14.4
  - 2024: 14.4
  - 2025: 14.3
  - 2026: 14.5
  - 2027: 14.6
- Current account balance (excluding official transfers) (percent of GDP):
  - 2019: -13.3
  - 2020: -14.5
  - 2021: -14.7
  - 2022: -15.7
  - 2023: -14.4
  - 2024: -13.5
  - 2025: -12.8
  - 2026: -11.8
  - 2027: -11.1
- Nominal GDP (in millions of U.S. dollars):
  - 2019: 17,134
  - 2020: 15,532
  - 2021: 16,679
  - 2022: 17,847
  - 2023: 18,925
  - 2024: 19,837
  - 2025: 20,706
  - 2026: 21,613
  - 2027: 22,499
- Per capita nominal GDP (U.S. dollars):
  - 2019: 3,443
  - 2020: 3,045
  - 2021: 3,191
  - 2022: 3,336
  - 2023: 3,457
  - 2024: 3,543
  - 2025: 3,618
  - 2026: 3,696
  - 2027: 3,767

### Central government fiscal operations (selected fiscal metrics)
- Revenue and grants (percent of GDP):
  - 2019: 23.1
  - 2020: 25.1
  - 2021: 25.7
  - 2022: 26.3
  - 2023: 25.5
  - 2024: 25.5
  - 2025: 25.5
  - 2026: 25.5
  - 2027: 25.5
- Tax revenue (percent of GDP):
  - 2019: 17.7
  - 2020: 19.1
  - 2021: 20.8
  - 2022: 21.0
  - 2023: 21.1
  - 2024: 21.1
  - 2025: 21.1
  - 2026: 21.3
- Clearance revenues (percent of GDP):
  - 2019: 14.2
  - 2020: 15.1
  - 2021: 16.2
  - 2022: 16.2
  - 2023: 16.2
  - 2024: 16.2
  - 2025: 16.2
  - 2026: 16.3
  - 2027: 16.3
- Grants (percent of GDP):
  - 2019: 2.9
  - 2020: 3.0
  - 2021: 1.8
  - 2022: 2.2
  - 2023: 1.3
  - 2024: 1.3
  - 2025: 1.3
  - 2026: 1.2
  - 2027: 1.2
- Total expenditure and net lending (percent of GDP):
  - 2019: 27.6
  - 2020: 32.8
  - 2021: 31.0
  - 2022: 30.8
  - 2023: 30.6
  - 2024: 30.7
  - 2025: 30.9
  - 2026: 31.1
  - 2027: 31.2
- Wages and salaries (percent of GDP):
  - 2019: 10.9
  - 2020: 12.9
  - 2021: 13.6
  - 2022: 13.7
  - 2023: 13.7
  - 2024: 13.8
  - 2025: 13.9
  - 2026: 14.1
  - 2027: 14.2
- Development expenditures (percent of GDP): 2.0 (2019), 1.8 (2020), 1.4 (2021–2027)
- Overall balance (commitment, before external support) (percent of GDP):
  - 2019: -7.3
  - 2020: -10.7
  - 2021: -7.1
  - 2022: -6.6
  - 2023: -6.4
  - 2024: -6.5
  - 2025: -6.7
  - 2026: -6.7
  - 2027: -6.8
- Overall balance (commitment) (percent of GDP):
  - 2019: -4.5
  - 2020: -7.7
  - 2021: -5.3
  - 2022: -4.5
  - 2023: -5.0
  - 2024: -5.2
  - 2025: -5.4
  - 2026: -5.5
  - 2027: -5.7
- Identified financing (percent of GDP):
  - 2019: 4.2
  - 2020: 7.7
  - 2021: 5.3
  - 2022–2027: -1.4 (each year)
- Financing gap / Residual (percent of GDP):
  - 2019: 0.3
  - 2020: 0.0
  - 2021: 0.0
  - 2022: 5.9
  - 2023: 6.5
  - 2024: 6.6
  - 2025: 6.9
  - 2026: 6.9
  - 2027: 7.1
- Central government debt (incl. arrears) (percent of GDP):
  - 2019: 34.5
  - 2020: 47.3
  - 2021: 49.3
  - 2022: 50.5
  - 2023: 52.7
  - 2024: 55.5
  - 2025: 58.6
  - 2026: 61.6
  - 2027: 64.8

### Financial Soundness Indicators (selected, in percent)
- Capital adequacy (all banks):
  - Tier I capital to risk-weighted assets:
    - Dec-17: 15.5
    - Dec-18: 16.0
    - Dec-19: 15.6
    - Dec-20: 13.9
    - Dec-21: 14.3
  - Regulatory capital to risk-weighted assets:
    - Dec-17: 16.6
    - Dec-18: 16.8
    - Dec-19: 16.6
    - Dec-20: 15.7
    - Dec-21: 16.1
- Asset quality:
  - Nonperforming loans (percent of total loans):
    - Dec-17: 2.3
    - Dec-18: 3.0
    - Dec-19: 4.1
    - Dec-20: 4.2
    - Dec-21: 4.2
  - Coverage ratio (provisions as percent of nonperforming loans):
    - Dec-17: 58.4
    - Dec-18: 86.2
    - Dec-19: 75.0
    - Dec-20: 86.1
    - Dec-21: 94.4
- Earnings and profitability:
  - Return on assets (ROA) (selected):
    - Dec-17: 1.5
    - Dec-18: 1.5
    - Dec-19: 1.3
    - Dec-21: 1.2
  - Return on equity (ROE):
    - Dec-17: 16.1
    - Dec-18: 15.2
    - Dec-19: 13.1
    - Dec-20 (Dec-20 quarterly entries): 9.3 (Dec-20)
    - Dec-21: 15.1
- Liquidity:
  - Liquid assets to total assets:
    - Dec-17: 32.3
    - Dec-18: 29.8
    - Dec-19: 32.0
    - Dec-20: 33.2
    - Dec-21: 33.2
  - Liquid assets to total deposits:
    - Dec-17: 41.6
    - Dec-18: 38.6
    - Dec-19: 40.9
    - Dec-20: 42.1
    - Dec-21: 42.0
  - Liquid assets to short-term liabilities:
    - Dec-17: 43.0
    - Dec-18: 42.2
    - Dec-19: 45.5
    - Dec-20: 47.5
    - Dec-21: 47.2

### Annex I — COVID-19 Vaccine Rollout (selected findings)
- Vaccination procurement and rollout:
  - West Bank and Gaza benefited from the multilateral COVAX initiative and other donations.
  - The PA officially kickstarted its vaccine campaign in March 2021.
  - By end-February 2022, some 8.4 million doses had been delivered, averaging 2.4 doses per target population.
- Vaccination coverage (target population = individuals 12 years and above):
  - By end-February 2022:
    - Around 2 million Palestinians had received at least one shot, representing around 57 percent of the targeted population.
    - West Bank: 1.3 million or 66 percent of target population.
    - Gaza Strip: 0.7 million or 45 percent of target population.
    - Fully vaccinated: 1.7 million people (49 percent).
      - West Bank fully vaccinated: 1.2 million or 62 percent of target population.
      - Gaza fully vaccinated: 0.5 million or 33 percent of target population.
- Booster campaign:
  - As of end-February 2022, 290,000 Palestinians or 8.3 percent of the population had received a booster shot.
  - Administration of the third “booster” dose to priority groups is ongoing, but progress is slow.
- Epidemiological notes:
  - The Omicron-wave peaked in early February and then quickly dropped off; this coincides with low levels of testing focused mainly on symptomatic or hospitalized cases.
  - Test positivity rate reached over 35 percent in late February.
  - Fatality rate in February stood at 0.35 percent.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### Annex II. Risk Assessment Matrix

### 1wbgea2022001 - Annex II. Risk Assessment Matrix

### Domestic Risks — overview and mitigation
- Relative likelihood: High
- Expected impact if realized: High
- Findings and expected impacts:
  - The PA’s fiscal trajectory remains unaltered.
  - Large fiscal deficits persist, financed by a rapidly increasing stock of arrears. Cascading arrears cause all-round liquidity shortages, damaging growth and financial stability. Debt (including arrears) is unsustainable.
- Policies to mitigate:
  - Pursue gradual fiscal consolidation, centered on expenditure reform.
  - Take stock of arrears and devise a strategy to clear them.
  - Ensure the banking system remains well capitalized.

### Domestic Risks — banking sector spillovers
- Relative likelihood: Medium/High
- Expected impact if realized: High
- Findings and expected impacts:
  - The PA’s fiscal trajectory, if unchecked, could hurt banks’ asset quality given the banking sector’s high direct and indirect exposure to the PA, potentially undermining financial stability and harming economic growth.
- Policies to mitigate:
  - Ensure that the banking system remains well capitalized.
  - Gradually reduce banks’ exposure to the PA.
  - Strengthen bank supervision and crisis management capacity.

### Domestic Risks — correspondent banking and AML/CFT
- Relative likelihood: High
- Expected impact if realized: High
- Findings and expected impacts:
  - Loss of Israeli-Palestinian correspondent bank relations would lead to trade and financial disruption and encourage a further shift into cash/informality. As a result, WBG’s financial system would suffer, harming growth.
- Policies to mitigate:
  - Strengthen the AML/CFT framework and build implementation capacity, including with technical assistance.
  - Work with Israeli counterparts to strengthen cross-border payment systems.

### Domestic Risks — social tensions and political context
- Relative likelihood: High
- Expected impact if realized: High
- Findings and expected impacts:
  - Unemployment, poverty, frustration with the lack of progress on the peace process and dissatisfaction with domestic politics may lead to escalation of civil unrest or another confrontation with Israel. This would undermine growth and intensify the humanitarian crisis in Gaza.
- Policies to mitigate:
  - Sound macroeconomic management and economic reform could help instill confidence and alleviate economic strain at the margin.
  - Note: economic policies can do little to mitigate discontent with the political situation and the lack of progress on peace.

### Domestic Risks — movement restrictions and donor support
- Israel tightens restrictions on movement of goods and people further
  - Relative likelihood: Medium
  - Expected impact if realized: High
  - Findings and expected impacts:
    - In response to unrest or renewed conflict, Israel may shut the border to people and constrain goods traffic further. Economic growth would be hit hard and quickly. Many Palestinian guest workers would lose their income, lowering transfers into WBG.
  - Policies to mitigate:
    - The authorities could try to seek additional grants to be able to partially compensate the population for the associated additional hardship.
- Donor support remains low or declines further
  - Relative likelihood: High
  - Expected impact if realized: Medium
  - Findings and expected impacts:
    - Donor support remains at its current low level or declines further. This would make the implementation of a reform agenda more difficult. Given that donor grants already stand at historic lows, the impact of a further decrease would worsen the baseline only modestly.
  - Policies to mitigate:
    - Pursue a comprehensive reform agenda that improves the macroeconomic situation.
    - Entice donors to contribute to this turn around through increased grants.

### Global Risks
- Outbreak of lethal and highly contagious COVID-19 variants
  - Relative likelihood: High
  - Expected impact if realized: Medium/High
  - Findings and expected impacts:
    - Recurring waves caused by new lethal and highly contagious COVID variants and associated restrictions would hurt growth, lead to job losses, adversely impact public finances, and could undermine bank asset quality.
  - Policies to mitigate:
    - Provide temporary targeted support to those in need by shifting spending away from lower priority areas, provided the fiscal situation allows it.
    - Strengthen banking sector crisis management capacity.
- Sharp increases in food and fuel prices, driven by the war in Ukraine
  - Relative likelihood: High
  - Expected impact if realized: Medium
  - Findings and expected impacts:
    - Global disruption in commodities markets as a consequence of the war in Ukraine and associated sanctions on Russia cause a spike in international wheat and oil prices, leading to sharp increases in retail prices of gasoline, flour, and bread.
  - Policies to mitigate:
    - Provide targeted and temporary support, provided the fiscal situation allows it.

### RAM methodological note
- The RAM shows events that could materially alter the baseline path.
- Relative likelihood categories: “low” = probability below 10 percent; “medium” = probability between 10 and 30 percent; “high” = probability between 30 and 50 percent.
- The RAM reflects staff views as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

---

### Annex III — Debt Sustainability Analysis (DSA) — key findings and projections

### Headline DSA finding
- With unchanged policies debt will rise from 34.5 percent of GDP pre-COVID to about 65 percent of GDP by 2027.
- A debt stock of this magnitude is unsustainable given West Bank and Gaza’s narrow revenue base, uncertainty over clearance revenues due to Israeli deductions, and structural restrictions on mobility of labor, goods and capital.
- Associated high gross financing needs present a key vulnerability. West Bank and Gaza is subject to considerable shocks, mainly political, that can further worsen debt sustainability.

### Structure of public debt — summary points
- At end-2021, gross public debt was estimated at 49.3 percent of GDP compared to 34.5 percent of GDP in 2019.
- Drivers of the increase: a deep 2020 recession, increased COVID-related spending (vaccine purchases, support to vulnerable groups), policy decisions (e.g., reinstatement of full wages for about 6,000 civil servants in Gaza), and political tensions.
- Arrears:
  - Domestic arrears are primarily to suppliers, contractors, the pension fund, and PA employees.
  - Expenditure arrears are defined as the difference between spending on a commitment and cash bases.
  - Pension fund arrears comprise civil servant and security personnel pensions and encompass required government and employee contributions that the government has not transferred to the pension fund.
  - The size of arrears is uncertain because of conflicting cross claims and data weaknesses; a reconciliation process is underway.
  - The authorities accumulate new arrears regularly reflecting high deficits and lack of financing options.
- Financing assumptions:
  - Arrears represent the main source of new financing in this DSA.
  - Additional domestic bank financing is assumed limited as banks’ exposure to the PA is already above prudential limits, but existing bank debt is assumed to be rolled over.
  - The government is unable to issue securities in domestic or international markets.
  - The DSA assumes no penalties or interest accruing on these arrears; contingent liability shock where debt stock in 2022 is 5 percent of GDP higher and subject to penalties/interest is included to account for arrears-related risks.
- Composition at end-2021:
  - Domestic debt (including arrears) represented 85 percent of total debt, with arrears the largest component.
  - External debt represented 15 percent of total debt; some 86 percent of foreign debt is long term.
  - Biggest external creditors: the Al Aqsa Fund (39 percent of external debt), World Bank (about 20 percent), and the Qatar National Bank (about 20 percent). Bilateral creditors (Italy, Spain) account for about 12 percent of external debt.

### Macroeconomic outlook (unchanged policies)
- Real growth projected to gradually decrease from 4 percent in 2022 to 2 percent over the medium term.
- Inflation expected to slowly decline to 2 percent.
- Large fiscal deficits in 2020–21 expected to come down somewhat but stay high at 5–6 percent of GDP.
- Under unchanged policies, the fiscal deficit is expected to gradually worsen over time.
- Considerable fiscal risks: political unrest, higher-than-expected deductions of clearance revenues related to prisoner payments, and a potentially larger stock of arrears.

### Debt trajectory and risks
- Baseline: gross public debt projected to increase to about 65 percent of GDP by 2027—an increase of more than 15 percentage points of GDP over 6 years.
- Vulnerabilities: narrow revenue base, unpredictable Israeli deductions on revenues collected on behalf of the PA, restrictions on movement, lack of financing options, donor dependence, and limited fiscal policy instruments.
- Stress scenarios:
  - Growth shock: public debt would reach 78 percent of GDP by 2027.
  - Combined macro-fiscal shock (growth shock + temporary fiscal deterioration): public debt would exceed 85 percent of GDP by 2027.
  - Contingent liability shock (one-time upfront increase in debt with penalties/interest): debt would reach about 80 percent of GDP by 2027.
  - Political unrest shock: temporary but sizable shock can lead to a sharp deterioration in deficits and debt, likely beyond authorities’ capacity to manage.

### Key quantitative tables and projections (selected exact figures)
- Debt levels:
  - 2019 gross debt: 34.5 (percent of GDP)
  - 2020 gross debt: 47.3 (percent of GDP)
  - 2021 gross debt: 49.3 (percent of GDP)
- Composition (2019–2021, in percent of GDP):
  - Gross debt liabilities: 34.5 (2019), 47.3 (2020), 49.3 (2021)
  - Domestic debt: 27.6 (2019), 39.3 (2020), 42.1 (2021)
  - Loans and overdraft: 8.9 (2019), 14.0 (2020), 13.7 (2021)
  - Arrears 1/: 18.6 (2019), 25.3 (2020), 28.4 (2021)
  - External debt: 6.9 (2019), 8.0 (2020), 7.2 (2021)
- Baseline projections (selected rows, in percent of GDP unless noted):
  - Nominal gross public debt: 50.7 (2022), 53.0 (2023), 55.8 (2024), 58.8 (2025), 61.8 (2026), 64.8 (2027)
  - Public gross financing needs: 7.5 (2022), 17.2 (2023), 17.0 (2024), 18.4 (2025), 16.0 (2026), 20.7 (2027), 20.9 (2027 column repetition)
  - Real GDP growth (percent): 6.0 (2021), 4.0 (2022), 3.5 (2023), 2.4 (2024), 2.0 (2025), 2.0 (2026), 2.0 (2027)
  - Inflation (GDP deflator, percent): 1.3 (2021), 2.9 (2022), 2.5 (2023), 2.4 (2024), 2.3 (2025), 2.3 (2026), 2.0 (2027)
  - Primary deficit (percent of GDP): 7.4 (2021), 4.6 (2022), 3.8 (2023), 4.3 (2024), 4.4 (2025), 4.6 (2026), 4.4 (2027) [see table for full-year mapping]
  - Change in gross public sector debt (cumulative, 2022-27): 15.6 (percent of GDP)
  - Identified debt-creating flows (cumulative, 2022-27): 15.5 (percent of GDP)
  - Primary deficit contribution (cumulative, 2022-27): 26.4 (percent of GDP)
  - Primary (noninterest) revenue and grants (cumulative, 2022-27): 153.9 (percent of GDP)
  - Primary (noninterest) expenditure (cumulative, 2022-27): 180.3 (percent of GDP)
  - Automatic debt dynamics contribution (cumulative, 2022-27): -10.9 (percent of GDP)
  - Interest rate/growth differential (cumulative, 2022-27): -10.9 (percent of GDP)
  - Of which: real interest rate (cumulative, 2022-27): -2.7 (percent of GDP)
  - Of which: real GDP growth (cumulative, 2022-27): -8.2 (percent of GDP)

### Alternative scenarios and stress-test outcomes (high-level)
- Historical scenario: slightly different paths for real GDP growth and effective interest rate; baseline remains weaker relative to historical scenario in some years.
- Constant Primary Balance scenario: assumes primary balance stays at -3.8 (percent of GDP) across projection years.
- Stress tests illustrated:
  - Primary Balance Shock: primary balance paths show deeper deficits in 2023–24 (e.g., -5.3, -5.4).
  - Real GDP Growth Shock: real GDP growth can fall to -2.0 (2023) and -3.1 (2024) under shock scenarios with primary balance deteriorations (e.g., -6.4, -8.8).
  - Real Interest Rate Shock: effective interest rate can rise to 3.1 (2024), 3.5 (2025), 4.3 (2026), 4.5 (2027).
  - Combined Macro-Fiscal Shock and Contingent Liability Shock: result in much higher gross nominal public debt paths, with public gross financing needs and debt-to-revenue ratios rising sharply.
- Risk assessment heat maps and percentiles indicate significant likelihood that debt and gross financing needs exceed common benchmarks under several shocks.

*Source: Annex II. Risk Assessment Matrix and Annex III. Debt Sustainability Analysis, 1wbgea2022001*

### Annex IV. Growth Under Reform Scenarios

### Annex IV. Growth Under Reform Scenarios

### Illustrative policy package (reforms modeled)
- Adoption and implementation of new legislation that eases and speeds licensing, improves the insolvency regime, and strengthens protection of minority investors, boosting private investment, including foreign direct investment.  
- Steady easing of restrictions on movement of goods and services between West Bank and Gaza and Israel by expanding the lists of A1/A2/B goods and curtailing the dual use list for both the West Bank and Gaza; and allowing free movement of agricultural and industrial goods.  
- Smoothing customs clearance and inspection.  
- Allowing higher labor mobility between West Bank and Gaza and Israel.  
- Improved access to land and water in Area C, elimination of physical, legal, regulatory, and bureaucratic constraints to Palestinian investment in the area, and lower transportation costs, with less checkpoints and use of all roads.

### Methodology: production-function and scenario construction
- Growth decomposed using a standard production function: Yt = At Ktα Lt1- α with α set at 0.33.  
- Capital stocks estimated using the perpetual inventory method with an initial assumed capital-output ratio of 3.  
- Annual depreciation rate set at 3 percent plus 5 percent additional depreciation during years of conflict. The additional depreciation was applied to both West Bank and Gaza stocks in 2000–02, and only to Gaza’s capital stock during the 2008–09, 2012, 2014, and 2021 conflicts.  
- Impact of reforms on labor, capital, and TFP growth anchored on a 2017 World Bank study, with levels of employment, investment, and TFP modified sequentially, adding each policy reform one at a time from the baseline to the full reform scenario.  
- Analysis conducted for the entire Palestinian economy (West Bank and Gaza combined) due to lack of comparable regional employment data for earlier years.

### Main quantitative assumptions and scenario outcomes
- Investment:
  - Investment to GDP ratio rises from 24.5 percent in 2017–20 to 32 percent under reforms.  
  - Baseline average investment over 2023–27 is 23 percent.  
  - Investment growth assumed concentrated in the West Bank.  
- Labor:
  - Labor’s contribution to growth expected to increase by 0.3 percentage points to 2.5 percentage points on average under reforms, compared to 2.2 percent points under the baseline.  
  - Higher labor mobility to Israel and settlements (where wages are higher) offsets part of reforms’ effects on domestic employment and skills mismatches persist.  
- Total Factor Productivity (TFP):
  - TFP growth assumed to increase to 0.5 percent per year compared to its 20-year average of 0.1 percent.  
  - This remains well below the 2004–13 high-growth period TFP average of 3.4 percent per year.  
- Aggregate growth:
  - Overall reforms would gradually increase the economy’s growth rate to 6 percent of GDP.  
- Alternative estimates and robustness:
  - Staff’s CGE-based estimates yield a real GDP level higher by USD 2.8 billion (in 2015 US dollars) in 2027 relative to baseline.  
  - A 2014 World Bank study estimated impacts between USD 2 billion and USD 3.1 billion (converted to 2015 USD for comparison).  
  - Increasing the depreciation rate from 3 percent to 5 percent lowered projected growth over 2023-2027 by just 0.1 percent per year.  
  - Staff estimates are consistent with SVAR-based estimates of public investment’s impact on domestic private investment and FDI.

### Caveats, exclusions, and additional considerations
- Analysis was not conducted separately for the West Bank and the Gaza Strip due to lack of comparable historical regional labor data.  
- The impact of lifting the Gaza blockade or reconciliation/reunification was not considered.  
- Effects of increased vocational training to bridge skill gaps were not modeled; such measures could further raise growth.  
- Reunification could boost growth but may increase public finance strain due to substantial fiscal costs of integration possibly exceeding Gaza’s revenue potential.  
- Scenarios do not assume any tax revenue from Area C.

*Source: Annex IV. Growth Under Reform Scenarios (IMF content provided).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1wbgea2022001.pdf_