## 1.   Digitalization and Financial Inclusion

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### Recent Economic Developments and Outlook
- Growth moderated to 4 percent in 2022 from 7 percent in 2021.
- Inflation increased to 3.7 percent on average over 2022, up from 1.2 percent in 2021.
- Spillovers from Russia’s war in Ukraine on the Palestinian economy were modest.
- Growth forecast to slow to 3.5 percent in 2023 and gradually decrease to a long-term potential rate of 2 percent over the medium term.
- Inflation projected to fall to 3.4 percent in 2023 and 2 percent over the medium term.
- Unemployment at end-2022:
  - West Bank: 12.1 percent (lowest since 2015); labor force participation increased to 47.3 percent.
  - Gaza: 44 percent; more than 60 percent of the population living below the poverty line, compared to 19 percent in the West Bank.
- External sector:
  - Imports estimated at 64 percent of GDP in 2022.
  - Exports estimated at 17.3 percent of GDP in 2022.
  - External current account deficit reached an estimated 12.2 percent of GDP in 2022, up from 8.2 percent of GDP in 2021.
  - Real effective exchange rate appreciated by a modest 0.3 percent.
- Contributing factors to weak growth: Israeli-imposed restrictions on movement of goods and people (including access to Area C), weak labor market outcomes, and low public and private investment.
- Data and policy notes:
  - PA subsidies and tax breaks cushioned impact of increased food and fuel import prices.
  - Food and fuel import prices decelerated during the second half of 2022.

### Fiscal Developments and Sustainability
- Fiscal outcomes:
  - Fiscal deficit in 2022: a modest 0.9 percent of GDP, compared with 5.2 percent in 2021.
  - Change in security sector pensions recording contributed around 1.2 percent of GDP to the decrease; fiscal accounts projections reflect this change.
- Policy measures and composition:
  - Temporary VAT exemptions on flour and bread; fuel subsidies increased to 1.1 percent of GDP (from 0.4 percent in 2021).
  - Mobilization of domestic tax revenues via broadening tax base, expanding revenue task force, improving coordination with customs police.
  - Launch in March 2022 of the e-VAT pilot where Palestinian and Israeli traders issue invoices digitally.
  - Missed some payments on the (partly donor-funded) cash transfer program for poor and vulnerable households.
  - Development spending remained well below pre-COVID levels.
  - Public sector employees and pensioners have been paid 80 percent of salaries/pensions (except lowest earners) since November 2021.
  - Portal set up to collect data on crossclaims between the Ministry of Finance (MoF) and local governments; no specific policy measures to contain net lending announced.
- Arrears and debt dynamics:
  - Accumulation of new arrears amounted to 4.6 percent of GDP in 2022, while 3.0 percent of GDP in old arrears were repaid.
  - Net arrears position: net 1.5 percent of GDP in 2022.
  - Government debt (including arrears) increased from 34.5 percent of GDP in 2019 to 50.2 percent of GDP in 2021.
  - Estimated debt declined to 48.1 percent of GDP at end-2022 (19.9 percent of GDP excluding arrears and promissory notes).
  - The 48.1 percent of GDP end-2022 debt stock number includes an estimated 1 percent of GDP in promissory notes, which the authorities do not record as part of their debt and the issuance of which they have discontinued.
  - Under unchanged policies, government debt (including arrears) projected to reach 54.4 percent of GDP by 2028.
- Structural fiscal constraints:
  - PA raises virtually no revenue from Gaza and East Jerusalem, while it spends about a third of its budget in these areas.
  - PA raises no significant revenue from Area C in the West Bank.
  - Disagreement between PA and Israel on amounts of revenues the GoI should transfer under the Paris Protocol (difference known as fiscal leakages).
  - Unilateral Israeli deductions for so-called “prisoner payments.”
  - International community donor grants are not projected to increase.

### Banking Sector Developments and Financial Stability
- Banking sector soundness and performance:
  - Regulatory capital at 16.3 percent of risk-weighted assets at end-2022; Basel III compliant.
  - Liquidity at 44 percent of short-term liabilities at end-2022.
  - Nonperforming loans at 4 percent; provisioning at 101 percent of NPLs.
  - Profitability boosted significantly above pre-pandemic levels due to increasing interest income.
  - Deposit growth fell significantly below credit growth.
  - Watchlist, substandard and doubtful loans have increased following expiration of COVID loan moratoria, partial payment of public sector salaries and interest rate hikes.
- Exposure and risks:
  - Net new arrears financed partly domestically; 2022 overall deficit financing included accumulation of new arrears.
  - Banks’ direct sovereign exposure at 20.2 percent of loans (end-2022Q3); loans to PA employees comprise an additional 17.3 percent of loans.
  - Banks hold NIS 4.5 billion (equivalent to 6.4 percent of assets) of excess shekel cash at end-2022Q3 due to limit on transfer of shekel cash from the West Bank to Israel.
  - GoI letters of immunity and indemnity to two Israeli correspondent banks offering clearing and settlement to Palestinian banks were renewed, allowing shekel correspondent banking relations (CBRs) to continue uninterrupted for now.
  - Threat of disruption of shekel CBRs, asset quality deterioration, and further interest rate increases are significant risks to financial stability.
- Authorities’ assessment:
  - Authorities broadly agree with staff’s 2023 outlook and assessment of risks.
  - They view the uptick in watchlist, substandard and doubtful loans as presenting manageable risks under close monitoring.
  - They recognize need for sustained fiscal reforms to restore sustainability of public finances and prevent potential spillovers to the banking sector.
  - Authorities worried about Israel’s retaliatory increase in deductions from clearance revenues.

### Socioeconomic and Security Risks
- Rising socioeconomic risks in tandem with security risks:
  - Inflation has eroded real incomes.
  - High unemployment rates, especially in Gaza and among youth.
  - Partial payment of public sector wages and pensions since November 2021 and scaled back social transfers have deteriorated socioeconomic conditions.
  - Public sector strikes have become frequent, centered on the education sector and closing public schools.
- Potential contagion channels:
  - Continued accrual of arrears to employees, suppliers and contractors impacts employees’ ability to service loans and complicates businesses’ cash flow management, potentially threatening solvency of key economic sectors and banks’ corporate loan portfolios.

### Convergence: The Paris Protocol and Integration Outcomes
- Paris Protocol (signed in 1994 for an interim period envisaged to be five years) established:
  - A customs union and de facto currency union between Israel and the Palestinian territories.
  - Six major areas covered: customs and taxes, labor, agriculture, industry, tourism, and monetary, financial and insurance issues.
- Key provisions and constraints:
  - The Protocol requires the Israeli shekel to serve as a means of payment for all purposes in WBG, including official transactions.
  - It requires Palestinian imports and exports from and to third countries to transit through Israeli ports or border crossings with Jordan and Egypt that are under Israeli control, subject to Israeli supervision and quantitative restrictions.
  - Allows limited deviation from Israeli trade policy (quotas, customs and tax rates, and product quality standards).
  - No explicit risk-sharing mechanisms or fiscal transfers included.
  - It foresaw free movement of goods and normal labor movement between the Israeli and Palestinian economies, though limitations have persisted.
- Realized outcomes and barriers to convergence:
  - Palestinian per capita income (in PPP terms) is still 1/15th that of Israel.
  - The ratio between average wages in Israel and West Bank and Gaza has hovered around 4.5 (3 for the West Bank and East Jerusalem) for the past decade.
  - Annual population growth rate: 2.5 percent.
  - Long-term growth potential: 2 percent.
  - Main barrier: raising Palestinian growth potential to achieve and sustain convergence with Israel.
  - Structural constraints: asynchronous business cycles, movement and access restrictions, limit on shipment of shekel cash to the BoI, adherence to Israeli trade and customs policies, lack of access to productive inputs including land in Area C.
  - Economic cost estimate: in Area C alone at a cumulative US$50 billion over the last two decades.

### Reform Agenda and Policy Recommendations
- Overview:
  - Income convergence requires Palestinian potential and actual growth to rise above current levels and above Israeli growth.
  - Achieving this requires contributions from the PA, Israel, and international community donors.
  - Key priorities: fuller labor, capital and goods mobility (including investment in Area C); resolving fiscal crisis and arrears; additional donor flows to facilitate reforms and support vulnerable groups.
- Structural reforms:
  - Loosening most Israeli restrictions has nearly three times larger growth impact than improving Palestinian business climate and electricity and water supply (IMF staff’s May 2022 Report to the AHLC).
  - Increase permits for Palestinians from West Bank and Gaza to work in Israel.
  - Business climate improvements: recently adopted companies and telecom laws; need for debt settlement law, competition law, consumer protection improvements.
  - Labor market policies: revise labor laws to be gender neutral; introduce legislation against sexual harassment; improve access to safe transportation and affordable childcare; ease movement restrictions; facilitate private sector job creation in high-productivity tradable services.
  - Job elasticity: a high elasticity of jobs to growth of 0.7.
- Fiscal reforms:
  - 2023 budget should be based on realistic expenditure and financing forecasts to create fiscal space for development spending and gradual normalization of public sector wage payments.
  - Plans to broaden tax base and increase domestic revenues slightly more than nominal GDP growth.
  - Authorities committed to a 1-for-2 hiring rule (could save 0.2 percent of GDP in the first year if fully implemented).
  - Recommendations: suspend salary increases and promotions in short term; reform allowances and automatic seniority-based promotions; broad-based civil service reform guided by a functional review.
  - Other fiscal drags: net lending estimated at 1.9 percent of GDP in 2022; address medical referral costs, reassess fuel subsidy policy, parametric pension reforms.
  - Fiscal leakages estimated at about 1.8 percent of 2022 GDP (VAT: 1/0.8; Allenby crossing fees: 0.1; Handling fee: 0.5 (of which: Fuel 0.2); Other: 0.4).
  - Since 2019 Israel has withheld an estimated US$630 million (3.7 percent of 2022 GDP) in clearance revenues related to prisoner payments.
  - Launch of e-VAT pilot in March is a first step; need to make e-VAT mandatory for Israeli traders as for Palestinian counterparts.
  - Transferal of tax revenue on economic activity in Area C (outside settlements and military locations) to the PA in line with the Paris Protocol would positively impact revenue.
- Public financial management and arrears strategy:
  - Improve timeliness of audit; State Audit and Administrative Control Bureau completed joint 2020–21 audit.
  - Move toward a medium-term budget framework with multi-annual commitment controls and undertake comprehensive stocktaking of arrears.
  - Adopt a strategy to gradually clear arrears via cash payments and securitization (issuance of government bonds) cautiously, given need for fiscal consolidation and strengthened debt management capacity.
- Financial sector policies:
  - Continue implementing 2019 Financial Sector Stability Review recommendations.
  - Priorities: enhance risk-based supervision; strengthen stress testing; ensure buffers remain sufficient; deploy macroprudential tools where necessary.
  - PMA actions: operationalize emergency liquidity assistance framework; revise risk-based supervision including AML/CFT risk-based supervision; strengthen bank resolution, crisis management and financial safety net frameworks.
  - Prepare for an NPL increase: issue instructions on collateral revaluation and use moral suasion for banks to retain part of current high profits to increase buffers.

### Digitalization, Payments Infrastructure, and Financial Inclusion
- PMA initiatives to promote digital payments and financial inclusion:
  - Lowered regulatory barriers to entry into the digital payment market.
  - Limited interchange and credit card fees.
  - Licensed new digital payments and e-commerce service providers.
  - Organized financial awareness campaigns to encourage the use of credit and debit cards and e-wallets.
  - Launched a regulatory sandbox to test innovative financial solutions and technologies.
- Payments infrastructure upgrades:
  - National payment switch recently upgraded to process point-of-sale and other non-bank payment service provider transactions (in addition to ATM withdrawals).
  - Development of an instant electronic payment and bill presentment system to support retail payments and electronic billing and payment.
  - Recent adoption of a new payments law allowing for the creation of financial digital IDs and aiding development of a digital government services platform.
- Expected benefits and operational notes:
  - Reforms can help reduce excess shekel cash in the banking system.
  - Israeli measure requiring Israeli employers to pay their Palestinian workers electronically should help reduce excess cash.
  - BoI could increase limits on regular shekel cash shipments to complement these reforms.

### Shekel Correspondent Banking Relationships (CBRs) and Excess Cash
- Operationalization of an alternative mechanism for shekel CBRs requires:
  - A commitment from Israel to connect its correspondent company to all licensed Palestinian banks on equal terms.
  - Israeli legislation needed to operationalize its correspondent company.
- Due diligence should start as soon as possible, especially on banks that do not currently have shekel CBRs.
- Related numeric detail from 2022: BoI allowed total cash shipments of NIS 25.5 billion.

### AML/CFT, Financial Stability, and Authorities’ Intentions
- Authorities committed to safeguarding financial stability and strengthening AML/CFT framework.
  - Disappointment expressed at further postponement of the MENAFATF onsite visit.
  - Authorities intend to follow up on MENAFATF recommendations quickly once they come out, likely asking for further IMF CD assistance.
- Authorities view upgrading domestic and cross-border payment infrastructure and setting up adequate oversight as key to:
  - Increasing standardization and interoperability of WBG’s payments systems.
  - Improving access to points of sale.
  - Making e-payments faster, more efficient, secure, and resilient than cash and cheques.
- PMA intends to:
  - Continue working with the BoI to operationalize an alternative mechanism for shekel CBRs.
  - Carefully monitor the impact of global and domestic interest rate hikes.
  - Intensify supervisory and regulatory oversight in light of risks to banks’ asset quality.
  - Strengthen the AML/CFT regime by addressing MENAFATF recommendations once they come out.

### Outlook, Risks, and Policy Priorities
- Macroeconomic outlook and risks:
  - Growth set to moderate as post-COVID recovery loses steam, Israeli-imposed restrictions persist, and the security situation worsens.
  - Unemployment decreased (driven by Palestinians finding employment in Israel and the settlements), but poverty remains widespread, especially in Gaza.
  - Longer-term growth projected below population growth, implying gradual erosion of living standards.
  - Public debt projected to continue unsustainable gradual increase over the medium term, largely driven by domestic arrears.
  - PA fiscal situation creates risks to the banking sector through its high but stable PA exposure and to the real economy through arrears financing.
  - Disruption of shekel CBRs and asset quality deterioration are further risks to the banking sector.
- Policy priorities and recommendations:
  - PA should develop a comprehensive macro-fiscal adjustment strategy to create fiscal space for public investment and social support, including:
    - Deep wage bill and other expenditure reforms.
    - Building on MoF’s revenue performance.
    - Seeking progress on outstanding fiscal files with Israel.
  - Use the 2023 budget as an opportunity to articulate policies toward fiscal adjustment.
  - Structural reforms: pursue further improvements to the business climate and domestic labor market.
  - Critical structural reform: easing of Israeli-imposed movement, access and investment restrictions to boost private-sector growth and job creation.
  - PMA should:
    - Intensify supervisory and regulatory oversight given risks to bank asset quality.
    - Strengthen AML/CFT by addressing MENAFATF recommendations once available.
    - Together with BoI, operationalize the alternative correspondent banking mechanism and work to resolve the excess cash problem.
  - Reform process could be supported by additional donor grants to help restore public debt sustainability and support the most vulnerable.

### Key Statistics and Projections (selected figures preserved exactly as in source)
- Per capita GDP: $3,647; 2022 est.
- Poverty rate: 14 percent in the West Bank and 53 percent in Gaza Strip; 2017 est.
- Real GDP (annual change, selected years): 2019: 1.4; 2020: -11.3; 2021: 7.0; 2022: 4.0; 2023: 3.5; 2024: 2.7; 2025: 2.4; 2026: 2.0; 2027: 2.0; 2028: 2.0
- Unemployment rate (period average): 25.4 (2019); 25.9 (2020); 26.4 (2021); 24.4 (2022); 24.2 (2023–2028 projected)
- CPI inflation rate (end-of-period): 1.3 (2019); 0.1 (2020); 1.3 (2021); 3.7 (2022); 2.8 (2023); 2.5 (2024); 2.2 (2025); 2.3 (2026); 2.0 (2027); 2.0 (2028)
- Gross capital formation: 26.8 (2019); 24.3 (2020); 25.5 (2021); 26.8 (2022); 24.7 (2023); 24.1 (2024); 23.7 (2025); 23.5 (2026); 23.0 (2027); 22.7 (2028)
- Gross national savings: 16.4 (2019); 12.1 (2020); 17.2 (2021); 14.6 (2022); 12.9 (2023); 12.9 (2024); 12.4 (2025); 12.5 (2026); 12.2 (2027); 12.2 (2028)
- Total revenues and grants (percent of GDP): 23.1 (2019); 25.3 (2020); 25.2 (2021); 27.6 (2022); 27.2 (2023); 26.7 (2024–2028 projected at 26.7)
- Revenues (percent of GDP): 20.3 (2019); 22.1 (2020); 23.4 (2021); 25.7 (2022); 25.4 (2023); 24.9 (2024); 24.9 (2025); 25.0 (2026); 25.0 (2027); 25.2 (2028)
- Grants (percent of GDP): 2.9 (2019); 3.1 (2020); 1.8 (2021); 1.9 (2022); 1.9 (2023); 1.8 (2024); 1.7 (2025); 1.7 (2026); 1.6 (2027); 1.6 (2028)
- Total Expenditure (percent of GDP): 27.6 (2019); 32.6 (2020); 30.4 (2021); 28.5 (2022); 29.5 (2023); 29.7 (2024); 30.0 (2025); 30.3 (2026); 30.5 (2027); 30.8 (2028)
- Overall balance (commitment, before external support, percent of GDP): -7.3 (2019); -10.5 (2020); -7.0 (2021); -2.8 (2022); -4.1 (2023); -4.8 (2024); -5.1 (2025); -5.3 (2026); -5.5 (2027); -5.7 (2028)
- Overall balance (commitment, percent of GDP): -4.5 (2019); -7.4 (2020); -5.2 (2021); -0.9 (2022); -2.2 (2023); -3.0 (2024); -3.3 (2025); -3.6 (2026); -3.9 (2027); -4.1 (2028)
- Identified financing (percent of GDP): 4.2 (2019); 7.4 (2020); 5.2 (2021); 0.9 (2022); -2.7 (2023–2028 projected at -2.7)
- Financing gap/residual (percent of GDP): 0.3 (2019); 0.0 (2020); 0.0 (2021); 0.0 (2022); 4.9 (2023); 5.7 (2024); 6.0 (2025); 6.3 (2026); 6.6 (2027); 6.8 (2028)
- Financing gap/discrepancy (in millions of U.S. dollars): 45.1 (2019); -0.1 (2020); 0.6 (2021); 29 (2022); 511 (2023); 1,142 (2024); 1,247 (2025); 1,342 (2026); 1,460 (2027); 1,580 (2028)
- Public debt (percent of GDP): 34.5 (2019); 47.1 (2020); 50.2 (2021); 48.1 (2022); 47.2 (2023); 47.7 (2024); 48.8 (2025); 50.4 (2026); 52.3 (2027); 54.4 (2028)
- Credit to the private sector (end-of-period, percent of GDP): 5.3 (2019); 5.6 (2020); 5.6 (2021); 6.7 (2022); 6.5 (2023); 6.8 (2024); 6.4 (2025); 5.9 (2026); 5.4 (2027); 5.0 (2028)
- Private sector deposits (end-of-period, percent of GDP): 10.0 (2019); 13.9 (2020); 8.3 (2021); -0.3 (2022); 5.0 (2023); 5.7 (2024); 6.2 (2025); 5.9 (2026); 5.4 (2027); 5.5 (2028)
- Current account balance (excluding official transfers, percent of GDP): -13.3 (2019); -14.5 (2020); -9.2 (2021); -13.4 (2022); -12.9 (2023); -12.3 (2024); -12.3 (2025); -12.0 (2026); -11.7 (2027); -11.3 (2028)
- Nominal GDP (in millions of U.S. dollars): 17,134 (2019); 15,532 (2020); 18,109 (2021); 19,530 (2022); 20,901 (2023); 22,045 (2024); 23,138 (2025); 24,120 (2026); 25,095 (2027); 26,109 (2028)
- Per capita nominal GDP (U.S. dollars): 3,443 (2019); 3,045 (2020); 3,464 (2021); 3,647 (2022); 3,815 (2023); 3,934 (2024); 4,039 (2025); 4,121 (2026); 4,198 (2027); 4,278 (2028)
- Financial Soundness Indicators (selected):
  - Tier I capital to risk-weighted assets: 15.5 (Dec-17); 16.0 (Dec-18); 15.6 (Dec-19); 15.5 (Mar-20); 15.2 (Jun-20); 15.0 (Sep-20); 13.9 (Dec-20); 14.1 (Mar-21); 14.3 (Jun-21); 14.6 (Sep-21); 14.4 (Dec-21); 14.3 (Mar-22); 14.7 (Jun-22); 14.3 (Sep-22); 14.6 (Dec-22)
  - Nonperforming loans (percent of total loans): 2.3 (Dec-17); 3.0 (Dec-18); 4.1 (Dec-19); 4.0 (Mar-20); 3.9 (Jun-20); 3.7 (Sep-20); 4.2 (Dec-20); 4.2 (Mar-21); 4.2 (Jun-21); 4.3 (Sep-21); 4.2 (Dec-21); 4.2 (Mar-22); 4.2 (Jun-22); 4.1 (Sep-22); 4.0 (Dec-22)
  - Coverage ratio (provisions as percent of nonperforming loans): 58.4 (Dec-17); 86.2 (Dec-18); 75.0 (Dec-19); 80.4 (Mar-20); 86.2 (Jun-20); 91.7 (Sep-20); 86.1 (Dec-20); 86.4 (Mar-21); 89.0 (Jun-21); 90.3 (Sep-21); 94.4 (Dec-21); 94.4 (Mar-22); 95.6 (Jun-22); 97.3 (Sep-22); 101.2 (Dec-22)

*Source: IMF staff compilation from the provided chapter content.*

### 1.   Digitalization and Financial Inclusion   ________________________________________________________ 18

### 1.   Digitalization and Financial Inclusion

### Recent Economic Developments and Outlook
- Growth moderated to 4 percent in 2022 from 7 percent in 2021.
- Inflation increased to 3.7 percent on average over 2022, up from 1.2 percent in 2021.
- Spillovers from Russia’s war in Ukraine on the Palestinian economy were modest.
- Growth forecast to slow to 3.5 percent in 2023 and gradually decrease to a long-term potential rate of 2 percent over the medium term.
- Inflation projected to fall to 3.4 percent in 2023 and 2 percent over the medium term.
- Unemployment at end-2022:
  - West Bank: 12.1 percent (lowest since 2015); labor force participation increased to 47.3 percent.
  - Gaza: 44 percent; more than 60 percent of the population living below the poverty line, compared to 19 percent in the West Bank.
- External sector:
  - Imports estimated at 64 percent of GDP in 2022.
  - Exports estimated at 17.3 percent of GDP in 2022.
  - External current account deficit reached an estimated 12.2 percent of GDP in 2022, up from 8.2 percent of GDP in 2021.
  - Real effective exchange rate appreciated by a modest 0.3 percent.
- Contributing factors to weak growth: Israeli-imposed restrictions on movement of goods and people (including access to Area C), weak labor market outcomes, and low public and private investment.
- Notes on data and measures:
  - PA subsidies and tax breaks cushioned impact of increased food and fuel import prices.
  - Food and fuel import prices decelerated during the second half of 2022.

### Fiscal Developments and Sustainability
- Fiscal outcomes:
  - Fiscal deficit in 2022: a modest 0.9 percent of GDP, compared with 5.2 percent in 2021.
  - Change in security sector pensions recording contributed around 1.2 percent of GDP to the decrease; fiscal accounts projections reflect this change.
- Policy measures and fiscal composition:
  - Temporary VAT exemptions on flour and bread; fuel subsidies increased to 1.1 percent of GDP (from 0.4 percent in 2021).
  - Mobilization of domestic tax revenues via broadening tax base, expanding revenue task force, improving coordination with customs police.
  - Launch in March 2022 of the e-VAT pilot where Palestinian and Israeli traders issue invoices digitally.
  - Missed some payments on the (partly donor-funded) cash transfer program for poor and vulnerable households.
  - Development spending remained well below pre-COVID levels.
  - Public sector employees and pensioners have been paid 80 percent of salaries/pensions (except lowest earners) since November 2021.
  - Portal set up to collect data on crossclaims between the Ministry of Finance (MoF) and local governments; no specific policy measures to contain net lending announced.
- Arrears and debt dynamics:
  - Accumulation of new arrears amounted to 4.6 percent of GDP in 2022, while 3.0 percent of GDP in old arrears were repaid.
  - Net arrears position: net 1.5 percent of GDP in 2022.
  - Government debt (including arrears) increased from 34.5 percent of GDP in 2019 to 50.2 percent of GDP in 2021.
  - Estimated debt declined to 48.1 percent of GDP at end-2022 (19.9 percent of GDP excluding arrears and promissory notes).
  - The 48.1 percent of GDP end-2022 debt stock number includes an estimated 1 percent of GDP in promissory notes, which the authorities do not record as part of their debt and the issuance of which they have discontinued.
  - Under unchanged policies, government debt (including arrears) projected to reach 54.4 percent of GDP by 2028.
- Structural fiscal constraints highlighted:
  - PA raises virtually no revenue from Gaza and East Jerusalem, while it spends about a third of its budget in these areas.
  - PA raises no significant revenue from Area C in the West Bank.
  - Disagreement between PA and Israel on amounts of revenues the GoI should transfer under the Paris Protocol (difference known as fiscal leakages).
  - Unilateral Israeli deductions for so-called “prisoner payments.”
  - International community donor grants are not projected to increase.

### Banking Sector Developments and Financial Stability
- Banking sector soundness and performance:
  - Regulatory capital at 16.3 percent of risk-weighted assets at end-2022; Basel III compliant.
  - Liquidity at 44 percent of short-term liabilities at end-2022.
  - Nonperforming loans at 4 percent; provisioning at 101 percent of NPLs.
  - Profitability boosted significantly above pre-pandemic levels due to increasing interest income.
  - Deposit growth fell significantly below credit growth.
  - Watchlist, substandard and doubtful loans have increased following expiration of COVID loan moratoria, partial payment of public sector salaries and interest rate hikes.
- Exposure and risks:
  - Net new arrears financed partly domestically; 2022 overall deficit financing included accumulation of new arrears.
  - Banks’ direct sovereign exposure at 20.2 percent of loans (end-2022Q3); loans to PA employees comprise an additional 17.3 percent of loans.
  - Banks hold NIS 4.5 billion (equivalent to 6.4 percent of assets) of excess shekel cash at end-2022Q3 due to limit on transfer of shekel cash from the West Bank to Israel.
  - GoI letters of immunity and indemnity to two Israeli correspondent banks offering clearing and settlement to Palestinian banks were renewed, allowing shekel correspondent banking relations (CBRs) to continue uninterrupted for now.
  - Threat of disruption of shekel CBRs, asset quality deterioration, and further interest rate increases are significant risks to financial stability.
- Authorities’ assessment:
  - Authorities broadly agree with staff’s 2023 outlook and assessment of risks.
  - They view the uptick in watchlist, substandard and doubtful loans as presenting manageable risks under close monitoring.
  - They recognize need for sustained fiscal reforms to restore sustainability of public finances and prevent potential spillovers to the banking sector.
  - Authorities worried about Israel’s retaliatory increase in deductions from clearance revenues.

### Socioeconomic and Security Risks
- Rising socioeconomic risks in tandem with security risks:
  - Inflation has eroded real incomes.
  - High unemployment rates, especially in Gaza and among youth.
  - Partial payment of public sector wages and pensions since November 2021 and scaled back social transfers have deteriorated socioeconomic conditions.
  - Public sector strikes have become frequent, centered on the education sector and closing public schools.
- Potential contagion channels:
  - Continued accrual of arrears to employees, suppliers and contractors impacts employees’ ability to service loans and complicates businesses’ cash flow management, potentially threatening solvency of key economic sectors and banks’ corporate loan portfolios.

### Convergence: The Paris Protocol
- The Paris Protocol on Economic Relations (signed in 1994 for an interim period envisaged to be five years) established:
  - A customs union and de facto currency union between Israel and the Palestinian territories.
  - Six major areas covered: customs and taxes, labor, agriculture, industry, tourism, and monetary, financial and insurance issues.
- Key provisions and constraints:
  - The Protocol requires the Israeli shekel to serve as a means of payment for all purposes in WBG, including official transactions.
  - It requires Palestinian imports and exports from and to third countries to transit through Israeli ports or border crossings with Jordan and Egypt that are under Israeli control, subject to Israeli supervision and quantitative restrictions.
  - Allows limited deviation from Israeli trade policy (quotas, customs and tax rates, and product quality standards).
  - No explicit risk-sharing mechanisms or fiscal transfers included.
  - It foresaw free movement of goods and normal labor movement between the Israeli and Palestinian economies, though limitations have persisted.

*Source: West Bank and Gaza — Recent Economic Developments and Outlook (excerpts).*

### 14.      The close trade and financial integration between Israel and the Palestinian territories

### 14.      The close trade and financial integration between Israel and the Palestinian territories

### Integration expectations and realized outcomes
- Customs and currency unions eliminate trade policy differentiation and exchange rate adjustments, and thus require other mechanisms (flexible labor, financial and goods markets; free flow of capital and goods; labor mobility) to manage shocks and foster convergence.
- Such arrangements are expected to lead to gradual income convergence by encouraging capital flows from advanced to “catching-up” economies and labor flows in the opposite direction; business cycles would become more synchronous over time.
- Convergence has not materialized:
  - Palestinian per capita income (in PPP terms) is still 1/15th that of Israel.
  - The ratio between average wages in Israel and West Bank and Gaza has hovered around 4.5 (3 for the West Bank and East Jerusalem) for the past decade.
  - Annual population growth rate: 2.5 percent.
  - Long-term growth potential: 2 percent.
  - Main barrier: raising Palestinian growth potential to achieve and sustain convergence with Israel.

- Structural and policy constraints limiting convergence:
  - Highly asynchronous business cycles between WBG and Israel render BoI monetary policy inadequate to manage short-term aggregate demand in WBG.
  - Labor, capital and goods do not move freely due to the Israeli permit system, closures, checkpoints, roadblocks, import and investment restrictions, and a limit on the shipment of shekel cash to the BoI.
  - Palestinian competitiveness is constrained by adherence to Israeli trade and customs policies and lack of access to productive inputs, including land in Area C.
  - The overall economic costs of these restrictions is large, estimated in Area C alone at a cumulative US$50 billion over the last two decades.
  - Trade with Israel has decreased over time; labor mobility is lower than in the early 2000s; WBG has become less competitive over time.

### Reform agenda — overview
- Income convergence requires Palestinian potential and actual growth to rise above current levels and above Israeli growth.
- Achieving this requires contributions from the PA, Israel, and international community donors.
- Key priorities: fuller labor, capital and goods mobility (including investment in Area C); resolving fiscal crisis and arrears; additional donor flows to facilitate reforms and support vulnerable groups.

### A. Structural reform — measures and needs
- Israeli-imposed movement, access, and investment restrictions and the near-total blockade of Gaza weigh heavily on growth.
  - IMF staff’s May 2022 Report to the AHLC: growth impact of loosening most Israeli restrictions is nearly three times larger than effects of improving Palestinian business climate and electricity and water supply.
  - Increasing permits for Palestinians from West Bank and Gaza to work in Israel is a positive step toward freer labor movement.
- Business climate improvements:
  - Recently adopted companies and telecom laws: faster, easier, more affordable business registration and licensing; stronger protection of minority investors; new telecom regulator; removal of regulatory barriers to formalize home-based businesses (facilitating female-headed business registration); telecom law to boost competition and digital transformation; PA task force on intellectual property protection.
  - Additional needed laws: debt settlement law (clear foreclosure and reorganization procedures), competition law, improvements to consumer protection law.
- Labor market policies:
  - Labor force participation rates remain stubbornly low, particularly for Palestinian women (among the lowest in the world).
  - Suggested actions: revise labor laws and regulations to be gender neutral; introduce legislation against sexual harassment in the workforce and allow/encourage women to file claims in court; explicitly prohibit gender discrimination in hiring, promotion, and pay.
  - Improved access to safe transportation and affordable childcare recommended.
  - Geographic fragmentation and spatial mismatch persist; easing Israeli-imposed movement restrictions would improve outcomes.
  - Facilitation of private sector job creation in high-productivity tradable services recommended.
  - Job elasticity: a high elasticity of jobs to growth of 0.7 suggests improved labor market outcomes and higher growth go hand in hand.
  - Donor funding of the PA’s National Employment Strategy and support for poor and vulnerable households recommended.
- Authorities’ stance:
  - Authorities agree restrictions are main bottleneck but see no counterpart in Israel for substantive discussion on easing them.
  - Authorities cite adoption of companies and telecom laws and approval of framework agreement to develop Gaza offshore gas field as evidence of reform resolve.
  - Plans to increase domestic electricity generation capacity (renewables) and develop transmission infrastructure, partly with donor funding.
  - GoI’s approval in principle to provide broadband frequencies for 4G in the West Bank is welcomed; concern remains that Gaza is limited to 2G frequencies.
  - Authorities assert economic reforms cannot substitute for a political solution.

### B. Fiscal reform — policies, constraints, and targets
- 2023 budget:
  - Likely continuation of current policies but lacking details on specific expenditure reforms.
  - Budget should be based on realistic expenditure and financing forecasts, create fiscal space for development spending and gradual normalization of public sector wage payments.
  - Legally due only end-March; preparation under way.
  - Plans to broaden tax base and increase domestic revenues slightly more than nominal GDP growth.
  - Authorities plan to contain spending; envisage modest cuts in health expenditure though concrete reforms are elusive.
  - Wage bill increases expected due to negotiated substantial wage hikes with teachers’, doctors’ and engineers’ unions; authorities committed to a 1-for-2 hiring rule (one new employee for every two who leave), which could save 0.2 percent of GDP in the first year if fully implemented.
  - If implemented, wage increases will further worsen public finances and arrears accumulation; envisaged fiscal deficit likely somewhat higher than the 2022 level.

- Revenue potential and tax administration:
  - Limits to additional revenues from tax administration reforms.
  - MoF revenue strategy focuses on bringing liberal professions into the tax net; access to taxpayer bank account information considered crucial.
  - Banking law requires a court order for sharing bank client information with tax authorities; suggested amendment to allow automatic exchange of basic bank information, with court-ordered access for detailed information upon suspicion of fraud or tax evasion.
  - Need for secure procedures and systems for tax authority information.

- Wage bill and spending controls:
  - 2022 wage bill accounted for 45.1 percent of total spending and 50 percent of total revenues (excluding grants), or above 90 percent of net revenues when including certain transfers.
  - Short-term recommendation: suspend salary increases and promotions.
  - Medium-term: reform generous allowances, automatic salary increases and promotions based on seniority; contain new hiring to the 1-for-2 rule; limit future wage increases.
  - Follow with broad-based civil service reform guided by a functional review of public sector employment.

- Other fiscal drags:
  - Net lending estimated at 1.9 percent of GDP in 2022.
  - Need to strengthen transparency and accountability (including Israeli deductions); medium-term reforms in intergovernmental fiscal relations; electricity and water sector reforms.
  - Medical referrals to private hospitals consume 90 percent of non-wage health spending; reducing costs requires strengthening public hospital capacity.
  - Overly generous pension benefits should be eliminated and parametric reforms implemented to ensure actuarial soundness.
  - Reassess fuel subsidy policy to General Petroleum Authority; consider targeted support to vulnerable groups instead.

- Fiscal leakages and arrears:
  - Annual fiscal leakages estimated at about 1.8 percent of 2022 GDP, comprising:
    - VAT: 1/0.8 (losses largely due to missing invoices).
    - Allenby crossing fees: 0.1.
    - Handling fee: 0.5 (of which: Fuel 0.2).
    - Other: 0.4.
  - Launch of e-VAT pilot in March is a first step; need to make e-VAT mandatory for Israeli traders as for Palestinian counterparts.
  - Exempting fuel imports from excise and VAT (rather than charging and refunding with 3 percent handling fee) seems opportune.
  - Important to ensure PA receives its share of additional revenues from GoI increases in bridge exit fees.
  - Revenues withheld unilaterally by Israel because of prisoner payments are considerable; since 2019 Israel has withheld an estimated US$630 million (3.7 percent of 2022 GDP) in clearance revenues related to prisoner payments.
  - Transferal of tax revenue on economic activity in Area C (outside settlements and military locations) to the PA in line with the Paris Protocol would positively impact revenue.

- Public financial management and arrears strategy:
  - Authorities have improved timeliness of audit; State Audit and Administrative Control Bureau completed joint 2020–21 audit.
  - Once liquidity crisis is addressed, move toward a medium-term budget framework with multi-annual commitment controls consistent with a medium-term macro-fiscal framework.
  - Undertake a comprehensive stocktaking of arrears and adopt a strategy to gradually clear them via cash payments and securitization (issuance of government bonds) as a step toward a government bond market — proceed cautiously given need for fiscal consolidation and strengthened debt management capacity.
  - Authorities recognize need for detailed realistic fiscal reforms to reduce spending, particularly the wage bill; adopted a decree mandating a 1-for-2 hiring rule.
  - Under pressure from public sector strikes, they agreed to substantially increase 2023 public sector wages, pending available liquidity; considering an emergency cash-based budget.

### C. Financial sector policies — stability and resiliency measures
- Continue implementing 2019 Financial Sector Stability Review recommendations to support stability and mitigate banking sector vulnerabilities.
- Key priorities (supported by IMF capacity development):
  - Enhance risk-based supervision.
  - Strengthen stress testing capabilities.
  - Ensure buffers remain sufficient to manage liquidity, credit, and concentration risks.
  - Deploy new macroprudential tools where necessary.
- PMA actions needed:
  - Operationalize emergency liquidity assistance framework.
  - Progress in revising risk-based supervision framework, including AML/CFT risk-based supervision.
  - Strengthen legal and operational bank resolution, crisis management and financial safety net frameworks.
- MENAFATF’s delay of planned onsite visit is a setback for AML/CFT reforms.
- Prepare for an NPL increase:
  - Issue instructions with explicit supervision guidelines on collateral revaluation, particularly estimation of liquidation costs.
  - Use moral suasion to convince banks to retain part of current high profits to increase buffers.

*Source: IMF staff chapter on “The close trade and financial integration between Israel and the Palestinian territories.”*

### 29.      The PMA has promoted the use of cashless means of payment to boost financial

### 1wbgea2023001 - 29.      The PMA has promoted the use of cashless means of payment to boost financial

### Digitalization and financial inclusion
- The PMA has launched initiatives to promote digital payments and foster greater financial inclusion:
  - Lowered regulatory barriers to entry into the digital payment market.
  - Limited interchange and credit card fees.
  - Licensed new digital payments and e-commerce service providers.
  - Organized financial awareness campaigns to encourage the use of credit and debit cards and e-wallets.
  - Launched a regulatory sandbox to test innovative financial solutions and technologies.
- Payments infrastructure upgrades underway:
  - National payment switch recently upgraded to process point-of-sale and other non-bank payment service provider transactions (in addition to ATM withdrawals).
  - Development of an instant electronic payment and bill presentment system to support retail payments and electronic billing and payment.
  - Recent adoption of a new payments law allowing for the creation of financial digital IDs and aiding development of a digital government services platform.
- Expected benefits and operational notes:
  - Reforms can help reduce excess shekel cash in the banking system.
  - Israeli measure requiring Israeli employers to pay their Palestinian workers electronically should help reduce excess cash.
  - BoI could increase limits on regular shekel cash shipments to complement these reforms.

### Shekel correspondent banking relationships (CBRs) and excess cash
- Operationalization of an alternative mechanism for shekel CBRs requires resolution of key issues:
  - A commitment from Israel to connect its correspondent company to all licensed Palestinian banks on equal terms.
  - Israeli legislation needed to operationalize its correspondent company.
- Due diligence should start as soon as possible, especially on banks that do not currently have shekel CBRs.
- Related numeric detail from 2022: BoI allowed total cash shipments of NIS 25.5 billion. (See IMF Country Report 2022/299 for details referenced in source.)

### AML/CFT and financial stability
- Authorities committed to safeguarding financial stability and strengthening AML/CFT framework.
  - Disappointment expressed at further postponement of the MENAFATF onsite visit.
  - Authorities intend to follow up on MENAFATF recommendations quickly once they come out, likely asking for further IMF CD assistance.
- Authorities view upgrading domestic and cross-border payment infrastructure and setting up adequate oversight as key to:
  - Increasing standardization and interoperability of WBG’s payments systems.
  - Improving access to points of sale.
  - Making e-payments faster, more efficient, secure, and resilient than cash and cheques.
- PMA intends to:
  - Continue working with the BoI to operationalize an alternative mechanism for shekel CBRs.
  - Carefully monitor the impact of global and domestic interest rate hikes.
  - Intensify supervisory and regulatory oversight in light of risks to banks’ asset quality.
  - Strengthen the AML/CFT regime by addressing MENAFATF recommendations once they come out.

### Outlook, risks, and policy recommendations
- Macroeconomic outlook and risks:
  - Growth set to moderate as post-COVID recovery loses steam, Israeli-imposed restrictions persist, and the security situation worsens.
  - Unemployment decreased (driven by Palestinians finding employment in Israel and the settlements), but poverty remains widespread, especially in Gaza.
  - Longer-term growth projected below population growth, implying gradual erosion of living standards.
  - Public debt projected to continue unsustainable gradual increase over the medium term, largely driven by domestic arrears.
  - PA fiscal situation creates risks to the banking sector through its high but stable PA exposure and to the real economy through arrears financing.
  - Disruption of shekel CBRs and asset quality deterioration are further risks to the banking sector.
- Policy priorities and recommendations:
  - PA should develop a comprehensive macro-fiscal adjustment strategy to create fiscal space for public investment and social support, including:
    - Deep wage bill and other expenditure reforms.
    - Building on MoF’s revenue performance.
    - Seeking progress on outstanding fiscal files with Israel.
  - Use the 2023 budget as an opportunity to articulate policies toward fiscal adjustment.
  - Structural reforms: pursue further improvements to the business climate and domestic labor market.
  - Critical structural reform: easing of Israeli-imposed movement, access and investment restrictions to boost private-sector growth and job creation.
  - PMA should:
    - Intensify supervisory and regulatory oversight given risks to bank asset quality.
    - Strengthen AML/CFT by addressing MENAFATF recommendations once available.
    - Together with BoI, operationalize the alternative correspondent banking mechanism and work to resolve the excess cash problem.
  - Reform process could be supported by additional donor grants to help restore public debt sustainability and support the most vulnerable.

### Key statistics and projections (selected figures preserved exactly as in source)
- Per capita GDP: $3,647; 2022 est.
- Poverty rate: 14 percent in the West Bank and 53 percent in Gaza Strip; 2017 est.
- Real GDP (annual change, selected years): 2019: 1.4; 2020: -11.3; 2021: 7.0; 2022: 4.0; 2023: 3.5; 2024: 2.7; 2025: 2.4; 2026: 2.0; 2027: 2.0; 2028: 2.0
- Unemployment rate (period average): 25.4 (2019); 25.9 (2020); 26.4 (2021); 24.4 (2022); 24.2 (2023–2028 projected)
- CPI inflation rate (end-of-period): 1.3 (2019); 0.1 (2020); 1.3 (2021); 3.7 (2022); 2.8 (2023); 2.5 (2024); 2.2 (2025); 2.3 (2026); 2.0 (2027); 2.0 (2028)
- Gross capital formation: 26.8 (2019); 24.3 (2020); 25.5 (2021); 26.8 (2022); 24.7 (2023); 24.1 (2024); 23.7 (2025); 23.5 (2026); 23.0 (2027); 22.7 (2028)
- Gross national savings: 16.4 (2019); 12.1 (2020); 17.2 (2021); 14.6 (2022); 12.9 (2023); 12.9 (2024); 12.4 (2025); 12.5 (2026); 12.2 (2027); 12.2 (2028)
- Total revenues and grants (percent of GDP): 23.1 (2019); 25.3 (2020); 25.2 (2021); 27.6 (2022); 27.2 (2023); 26.7 (2024–2028 projected at 26.7)
- Revenues (percent of GDP): 20.3 (2019); 22.1 (2020); 23.4 (2021); 25.7 (2022); 25.4 (2023); 24.9 (2024); 24.9 (2025); 25.0 (2026); 25.0 (2027); 25.2 (2028)
- Grants (percent of GDP): 2.9 (2019); 3.1 (2020); 1.8 (2021); 1.9 (2022); 1.9 (2023); 1.8 (2024); 1.7 (2025); 1.7 (2026); 1.6 (2027); 1.6 (2028)
- Total Expenditure (percent of GDP): 27.6 (2019); 32.6 (2020); 30.4 (2021); 28.5 (2022); 29.5 (2023); 29.7 (2024); 30.0 (2025); 30.3 (2026); 30.5 (2027); 30.8 (2028)
- Overall balance (commitment, before external support, percent of GDP): -7.3 (2019); -10.5 (2020); -7.0 (2021); -2.8 (2022); -4.1 (2023); -4.8 (2024); -5.1 (2025); -5.3 (2026); -5.5 (2027); -5.7 (2028)
- Overall balance (commitment, percent of GDP): -4.5 (2019); -7.4 (2020); -5.2 (2021); -0.9 (2022); -2.2 (2023); -3.0 (2024); -3.3 (2025); -3.6 (2026); -3.9 (2027); -4.1 (2028)
- Identified financing (percent of GDP): 4.2 (2019); 7.4 (2020); 5.2 (2021); 0.9 (2022); -2.7 (2023–2028 projected at -2.7)
- Financing gap/residual (percent of GDP): 0.3 (2019); 0.0 (2020); 0.0 (2021); 0.0 (2022); 4.9 (2023); 5.7 (2024); 6.0 (2025); 6.3 (2026); 6.6 (2027); 6.8 (2028)
- Financing gap/discrepancy (in millions of U.S. dollars): 45.1 (2019); -0.1 (2020); 0.6 (2021); 29 (2022); 511 (2023); 1,142 (2024); 1,247 (2025); 1,342 (2026); 1,460 (2027); 1,580 (2028)
- Public debt (percent of GDP): 34.5 (2019); 47.1 (2020); 50.2 (2021); 48.1 (2022); 47.2 (2023); 47.7 (2024); 48.8 (2025); 50.4 (2026); 52.3 (2027); 54.4 (2028)
- Credit to the private sector (end-of-period, percent of GDP): 5.3 (2019); 5.6 (2020); 5.6 (2021); 6.7 (2022); 6.5 (2023); 6.8 (2024); 6.4 (2025); 5.9 (2026); 5.4 (2027); 5.0 (2028)
- Private sector deposits (end-of-period, percent of GDP): 10.0 (2019); 13.9 (2020); 8.3 (2021); -0.3 (2022); 5.0 (2023); 5.7 (2024); 6.2 (2025); 5.9 (2026); 5.4 (2027); 5.5 (2028)
- Current account balance (excluding official transfers, percent of GDP): -13.3 (2019); -14.5 (2020); -9.2 (2021); -13.4 (2022); -12.9 (2023); -12.3 (2024); -12.3 (2025); -12.0 (2026); -11.7 (2027); -11.3 (2028)
- Nominal GDP (in millions of U.S. dollars): 17,134 (2019); 15,532 (2020); 18,109 (2021); 19,530 (2022); 20,901 (2023); 22,045 (2024); 23,138 (2025); 24,120 (2026); 25,095 (2027); 26,109 (2028)
- Per capita nominal GDP (U.S. dollars): 3,443 (2019); 3,045 (2020); 3,464 (2021); 3,647 (2022); 3,815 (2023); 3,934 (2024); 4,039 (2025); 4,121 (2026); 4,198 (2027); 4,278 (2028)
- Financial Soundness Indicators (selected):
  - Tier I capital to risk-weighted assets: 15.5 (Dec-17); 16.0 (Dec-18); 15.6 (Dec-19); 15.5 (Mar-20); 15.2 (Jun-20); 15.0 (Sep-20); 13.9 (Dec-20); 14.1 (Mar-21); 14.3 (Jun-21); 14.6 (Sep-21); 14.4 (Dec-21); 14.3 (Mar-22); 14.7 (Jun-22); 14.3 (Sep-22); 14.6 (Dec-22)
  - Nonperforming loans (percent of total loans): 2.3 (Dec-17); 3.0 (Dec-18); 4.1 (Dec-19); 4.0 (Mar-20); 3.9 (Jun-20); 3.7 (Sep-20); 4.2 (Dec-20); 4.2 (Mar-21); 4.2 (Jun-21); 4.3 (Sep-21); 4.2 (Dec-21); 4.2 (Mar-22); 4.2 (Jun-22); 4.1 (Sep-22); 4.0 (Dec-22)
  - Coverage ratio (provisions as percent of nonperforming loans): 58.4 (Dec-17); 86.2 (Dec-18); 75.0 (Dec-19); 80.4 (Mar-20); 86.2 (Jun-20); 91.7 (Sep-20); 86.1 (Dec-20); 86.4 (Mar-21); 89.0 (Jun-21); 90.3 (Sep-21); 94.4 (Dec-21); 94.4 (Mar-22); 95.6 (Jun-22); 97.3 (Sep-22); 101.2 (Dec-22)

*Source: IMF staff compilation from the provided chapter content.*

### Annex I. Risk Assessment Matrix

### Annex I. Risk Assessment Matrix

### Overview: Purpose and Likelihood Definitions
- The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff).
- Relative likelihood definitions (staff’s subjective assessment):  
  - “low” = probability below 10 percent  
  - “medium” = probability between 10 and 30 percent  
  - “high” = probability between 30 and 50 percent
- The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non‑mutually exclusive risks may interact and materialize jointly.

### Domestic Risks
- High likelihood / High expected impact — The PA’s fiscal trajectory remains unaltered.  
  - Expected impact: Significant fiscal deficits persist, financed by an 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.

- Medium/High likelihood / High expected impact — Fiscal crisis spilling over to the banking sector.  
  - Expected impact: 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.

- High likelihood / High expected impact — Reduced financial services by Israeli correspondent banks.  
  - Expected impact: Loss of Israeli-Palestinian correspondent bank relations would lead to trade and financial disruption which would encourage a further shift into cash/informality. As a result, WBG’s financial system would suffer, harming growth.  
  - Policies to mitigate: Work with the Israeli authorities to adopt a long-term alternative for the current CBRs. Strengthen the AML/CFT framework and build implementation capacity, including with technical assistance. Work with Israeli counterparts to strengthen cross-border payment systems.

- High likelihood / High expected impact — Escalating social and security tensions due to lack of opportunities or prospects for peace.  
  - Expected impact: Unemployment, poverty, frustration with the lack of progress on the peace process, dissatisfaction with domestic politics and Israeli government policies affecting Palestinians may increase civil unrest or lead to another military confrontation with Israel in Gaza. This would undermine growth and worsen 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. However, economic policies can do little to mitigate discontent with the political situation and the lack of progress on the peace process.

- Medium/High likelihood / High expected impact — Israel tightens restrictions on movement of goods and people further.  
  - Expected impact: 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 income 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.

- High likelihood / Medium expected impact — Donor support remains low or declines further.  
  - Expected impact: Donor support remains at its current low level or declines further. A decline would impact support for poor and vulnerable households and would make PA reform efforts more difficult. Given that donor grants already are at historic lows, a further decrease would worsen the growth outlook 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
- Medium likelihood / Medium expected impact — Abrupt global slowdown or recession.  
  - Expected impact: This results in lower exports due to weakened external demand, slower growth, and job losses, adversely impacting 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. Strengthen banking sector crisis management capacity.

- High likelihood / Medium expected impact — Intensifying spillovers from Russia’s war in Ukraine and commodity price shocks.  
  - Expected impact: Further sanctions resulting from the war and related uncertainties exacerbate trade and financial disruptions and commodity price volatility. This may lead to price and real sector volatility, food insecurity, social unrest, and acute food and energy crises.  
  - Policies to mitigate: Provide targeted and temporary support, provided the fiscal situation allows it.

### Key statistics, baseline projections, and debt observations (as reported)
- West Bank and Gaza is in debt distress as evidenced by the accumulation of domestic arrears of almost 30 of GDP.  
- Domestic debt (including arrears and promissory notes) represented 85 percent of total debt at end-2022.  
- Arrears are the largest component of domestic debt, representing more than double the amount of bank debt. Almost half of the arrears are to the public sector pension fund, resulting in unfunded liabilities.  
- External debt represented about 15 percent of total debt.  
- Baseline macro projections under unchanged policies:  
  - Economic growth is expected to decrease to 2 percent per year over the medium term.  
  - Inflation is expected to gradually converge to near 2 percent.  
  - Public finances are expected to worsen, with the fiscal deficit expected to rise to around 4 percent of GDP.  
- Financing assumptions under the baseline: new financing is assumed to be mainly in the form of arrears; domestic bank financing is assumed to be limited.  
- Reported gross debt liabilities (In percent of GDP):  
  - Gross Debt Liabilities: 2019 34.5, 2020 47.1, 2021 50.2, 2022 48.1  
  - Domestic debt: 2019 27.6, 2020 39.1, 2021 43.1, 2022 40.8  
  - Loans and overdrafts: 2019 8.9, 2020 14.0, 2021 13.5, 2022 12.6  
  - Promissory notes 1/: 2019 ..., 2020 ..., 2021 2.0, 2022 1.0  
  - Arrears 1/: 2019 18.6, 2020 25.1, 2021 27.7, 2022 27.2  
  - External debt: 2019 6.9, 2020 8.0, 2021 7.0, 2022 7.3  
  - (Sources: Ministry of Finance; and IMF staff estimates. 1/ Figures are estimates due to insufficient official data.)  
- Medium-term debt projections under unchanged policies: gross public debt is projected to increase to about 54 percent of GDP by 2028 and then rise further to 68 percent of GDP by 2032.  
- SRDSF realism-tool findings summarized: no overoptimism concerns identified for debt projections, fiscal adjustment, or baseline real GDP growth relative to historical and cross-country distributions.  
- Debt Fanchart diagnostics and medium-term risk:  
  - Fanchart width is 59.4 (higher than in most other countries), indicating considerable uncertainty.  
  - Probability of debt not stabilizing is high.  
  - Terminal debt level interacted with institutional quality is in the 50–75th percentile, suggesting low debt carrying capacity.  
  - Conclusion: Debt Fanchart Index points to high solvency risks and suggests need for additional fiscal consolidation measures beyond those envisaged in the baseline.  
- Liquidity (GFN) assessment: GFN Financeability index is moderate because most public debt is in domestic currency and nonmarketable and most debt is in the form of accounts payable (domestic arrears). Projected GFNs are steadily increasing over the medium term (more so under a stress scenario), driven primarily by higher debt service rather than fiscal balances, suggesting the need for restructuring arrears. The module may underestimate liquidity risks given frequent episodes of political and social instability and limited financing options.

*Prepared by IMF staff; Risk Assessment Matrix and accompanying analysis as presented in the Annex.*

### 10. Uncertainty about liabilities presents an additional risk not captured by the fanchart

### 10. Uncertainty about liabilities presents an additional risk not captured by the fanchart

### Uncertainty over liabilities and modeling approach
- Uncertainties arise from:
  - uncertainty over the size of accumulated arrears; and
  - limited central government coverage of official debt statistics.
- The possible impact of these uncertainties is modeled as a contingent shock to the debt stock.
- Modeled effects of the contingent shock:
  - pushes the stock of debt to the 75–95th percentile of possible trajectories (Table 6B);
  - leads to a permanent increase in the stock of debt; and
  - causes a temporary spike and permanently higher Gross Financing Needs (GFNs) (Table 6C).

### Debt Sustainability Assessment (DSA) — key findings
- Without policy changes, public debt is unsustainable.
- The large and growing stock of arrears indicates debt distress.
- Public debt is projected to continue to rise over the long term in the absence of adjustment policies.
- Restoring debt sustainability will require coordinated transformative reform by the Palestinian Authority, Israel, and donors, as documented in IMF staff’s May 2022 Report to the AHLC.

### Risk assessment and indicators
- Overall assessment: The overall risk of sovereign stress is high, reflecting a high level of vulnerability in the near- and medium-term.
- Drivers of medium- and long-term risks:
  - limited access to finance;
  - Israeli restrictions on the movement of goods, capital, and people;
  - weak institutions;
  - narrow debt coverage and weak subnational governments posing contingent liabilities to the central government;
  - political and social instability;
  - lack of access to productive resources, uncertainty surrounding economic reforms, and increasing climate change pressures.
- Commentary: Medium-term liquidity risks, as analyzed by the GFN Financeability Module, may be underestimated because of political uncertainty and social tensions. GFN may also be underestimated because it is unclear if the private sector will accept continued accumulation of arrears and because of contingent liabilities from local governments and the pension fund.

### Selected quantitative indicators (from Table 6 and related tables)
- Debt fanchart width: 59.4
- Probability of debt not stabilizing (pct): 94.9
- Terminal debt level x institutions index: 38.0
- Debt fanchart index: 2.5
- Average GFN in baseline: 14.55
- Bank claims on government (pct bank assets): 12.23
- Change in claims on government in stress (pct bank assets): 16.65
- GFN financeability index: 14.4
- Prob. of missed crisis, 2023-2028 (if stress not predicted): 54.5 pc
- Prob. of false alarm, 2023-2028 (if stress predicted): 9.1 pct
- Baseline public debt (selected years, Percent of GDP) (Table 4):
  - Actual 2022: 48.1
  - 2023: 47.0
  - 2024: 47.4
  - 2025: 48.4
  - 2026: 50.0
  - 2027: 52.0
  - 2028: 54.4
  - 2029: 56.9
  - 2030: 60.0
  - 2031: 63.7
  - 2032: 68.2
- Gross Financing Needs (Percent of GDP) (Table 4, selected):
  - 2022: 4.5
  - 2023: 10.4
  - 2024: 10.8
  - 2025: 14.1
  - 2026: 16.7
  - 2027: 17.4
  - 2028: 17.9
  - 2029: 18.8
  - 2030: 22.0
  - 2031: 23.7

### Policy implications and recommendations
- Immediate implication: Contingent liabilities and arrears uncertainty represent additional downside risks not fully captured by standard fanchart and GFN tools; these risks warrant explicit consideration in policy design and contingency planning.
- Restoring sustainability requires:
  - coordinated transformative reform by the Palestinian Authority, Israel, and donors; and
  - financial contributions and policy actions aligned with the IMF staff’s May 2022 Report to the AHLC.
- Fiscal strategy priorities (from DSA commentary):
  - strengthen public financial management and expand debt coverage and disclosures to reduce uncertainty about liabilities;
  - address the large and growing stock of arrears to mitigate debt distress and reduce GFN pressures;
  - continue reforms to generate jobs for a growing population and mitigate risks from climate change;
  - plan for medium-term liquidity needs recognizing that GFN estimates may be understated given contingent liabilities and arrears accumulation.

*Source: IMF staff .*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1wbgea2023001.pdf_