## 1wbgea2023003

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### Economic divergence, recent developments, and outlook
- Real GDP growth: 3.9 percent in 2022; projected 3 percent in 2023; converging to a 2 percent potential rate over the medium term.
- Inflation: projected at 3.4 percent in 2023 and 2 percent over the medium term.
- Current account deficit: widened to 15.0 percent of GDP in 2022 (from 9.8 percent in 2021).
- Imports: rose by 27.5 percent in 2022.
- External balance drivers: substantial net income inflows partly offset trade deterioration due to a further increase in the number of Palestinian workers in Israel.
- Growth headwinds: deteriorating political, security, and social situation; lower growth in Israel; restrictions on movement of goods, people, and investment.

### Economic divergence — key facts and structural drivers
- Gaza long-run outcomes and indicators:
  - Gaza per capita income: fell by an average of 2½ percent per year between 2007–22; by 2022 it stood at less than a third of that in the West Bank.
  - Gaza labor force unemployment: around 45 percent.
  - Population below national poverty line: Gaza 53 percent.
- West Bank indicators:
  - Population below national poverty line: West Bank 13 percent.
  - Unemployment (West Bank): 14 percent (two figures reported for West Bank poverty and unemployment respectively).
- Structural differences and drivers:
  - Gaza reliance: mainly government consumption; low investment concentrated in construction.
  - Capital stock: Gaza’s capital stock “now barely stands at its level of 15 years ago”; West Bank’s capital stock “more than doubling” over the same period.
  - Trade openness (sum of imports and exports over GDP): Gaza 61 percent; West Bank 91 percent.
- Preconditions for improvement:
  - Significant easing of restrictions on movement of goods, labor, and capital.
  - Continued international donor support to develop critical infrastructure (electricity generation and transmission; fresh and waste water) and reduce poverty.

### Fiscal sector and public finances — budget, revenues, arrears, and risks
- 2023 budget and execution:
  - The 2023 budget projects the deficit to almost double to 1.9 percent of GDP in commitment terms.
  - Authorities are executing the budget on a month-to-month cash basis amid rising liquidity constraints.
  - The wage bill may exceed budgeted amounts following substantial 2023 wage hikes that more than undo potential savings from the 1-for-2 hiring rule.
  - Development expenditure is budgeted to double but financing assumes further substantial revenue gains and increased donor support.
- Clearance revenues and unilateral deductions:
  - Doubling of unilateral deductions from clearance revenues by the GoI under the 2018 Israeli Palestinian Prisoners Law in 2023H1.
  - The amount withheld since 2019 is estimated at US$786 million (4.4 percent of 2023 GDP).
- Arrears and public debt:
  - Estimated end-2022 stock of arrears: 27.8 percent of GDP.
  - Public debt (including arrears) projected to resume an increasing trend after a temporary decline; by 2028 public debt is projected at 51 percent of GDP, up from 49 percent in 2022.
- Fiscal constraints and risks:
  - No access to international capital markets; authorities limit bank borrowing to contain banks’ sovereign exposure.
  - Any shortfall in budget financing will likely translate into further buildup of domestic arrears.
  - Delivery of core government services at risk (education, health), with reported funding shortfalls and strikes affecting service provision.

### Fiscal leakages and outstanding fiscal files with Israel
- Overall fiscal leakages: estimated at around 1½ percent of GDP on an annual basis.
- Recent procedural developments:
  - Halving of the handling fee charged on Palestinian fuel imports (to 1.5 percent).
  - Procedural progress with Israeli legislation mandating the use of the e-VAT system for Israeli traders.
- Outstanding fiscal files requiring tangible outcomes:
  - (i) lowering the handling fees on imports, including doing away with them altogether on fuel;
  - (ii) transferring to the PA the tax revenue on Israeli economic activity in Area C in line with the Paris Protocol;
  - (iii) fully sharing the Allenby bridge crossing fees;
  - (iv) transferring customs authority to the PA.
- Box summary: Area C context and taxation responsibilities per Annex III (Oslo II), with the PA noting no tax proceeds remitted from Israel on Israeli economic activities in Area C.

### Expenditure reform priorities — wage bill, pensions, and efficiency
- Wage bill:
  - In 2022, the wage bill stood at 43 percent of total spending (above the 90th percentile of peer countries).
  - In 2022, the wage bill stood at 48 percent of total revenues excluding grants, or almost 90 percent of net revenues when including certain transfers labeled as “semi-wages”.
  - Growth in wage bill driven mainly by salary increases sustained by a generous system of allowances.
  - Recent measures: re-deploy personnel; hire only 1 new public employee for every 2 that leave public service (implementation issues noted).
  - Short-term recommendation: consider temporarily suspending part of salary and allowance increases—particularly for public employees above a certain grade—and promotions.
  - Medium-term recommendation: deeper reforms of salary and allowance structure, integrate allowances into base pay, reform criteria/procedures for salary increases and promotions; conduct functional review.
- Pension system:
  - Public pension outlays: around 4 percent of GDP; current beneficiaries represent only 1.5 percent of the population.
  - De jure scheme II includes a pre-funded defined-benefit (DB) component, but PA has not been able to pay full contributions.
  - Accumulated consequences:
    - (i) a sizeable stock of arrears to the PPA (estimated at 14 percent of GDP in 2023);
    - (ii) invested pension fund assets far insufficient to meet future obligations.
  - Operational practice: scheme II effectively operated as a PAYGo system; recommendation to align de jure and de facto systems toward a DB contributory PAYGo system, stop further accumulation of PA contribution arrears, and transform existing arrears into equivalent future budgetary obligations.
  - Suggested parametric reforms: increase mandatory and early retirement ages; reduce early retirement benefits; revise accrual rate; modestly increase contribution rate.
- Other spending efficiency:
  - Net lending: annual expense projected to remain at almost 2 percent of GDP in 2023; portal to reconcile cross-claims between PA and LGUs.
  - Fuel subsidies: untargeted and regressive fuel subsidies estimated at 0.9 percent of 2023 GDP; medium-term recommendation to gradually phase out and reallocate to targeted social spending.
  - Health referrals: still account for more than ¾ of non-wage health spending; recommended reforms include alleviating capacity constraints, prioritize investment to reduce referrals, extend cost-negotiation practices, enhance coordination with Israeli system to reduce permit delays and denials, and increase transparency in deductions from clearance revenues.

### Public financial management, arrears, and IMF support
- Strengthen PFM to promote policy-based budget preparation and support arrears management.
- Completion of the 2020-21 audit by the State Audit Bureau improved timeliness of financial account audits.
- Resume gradual transition toward a medium-term fiscal framework (MTFF) once liquidity constraints ease.
- Need for comprehensive stocktaking of arrears and credible repayment plan.
- Authorities continue to benefit from IMF capacity development across PFM, revenue administration, and financial sector areas.

### Financial sector developments, exposure, and stability measures
- Banking sector soundness (selected indicators):
  - Banks’ capital: 16.4 percent of risk-weighted assets at end-June 2023.
  - 2023Q2 profitability: 15 percent return on equity.
  - Liquidity: 40.3 percent of short-term liabilities.
  - Non-performing loans (NPLs): 4.1 percent of total loans at end-2023Q2.
  - Aggregate NPLs, watchlist, substandard and doubtful loans: 11.1 percent by end-2023Q2.
- Exposure to the PA:
  - Banks’ direct exposure to the PA: 20 percent of total loans (about 11 percent of assets or 101 percent of equity) at end-June 2023.
  - Loans to PA employees add an additional 16 percent of loans (9 percent of assets) in indirect exposure.
  - Total exposure (direct and indirect): 36 percent of total loans.
- Excess physical shekel cash holdings:
  - Exceptional shipment authorized by the Bank of Israel reduced banks’ shekel holdings to NIS 5.1 billion (6.6 percent of total assets) at end-2023Q2.
  - Excess physical shekel holdings increased to NIS 6 billion by end-July 2023.
  - Less than half the estimated NIS 1 billion that permitted Palestinian workers earn in Israel each month is currently paid through bank transfers.
- Correspondent banking and CBR risks:
  - Extension to end-March 2024 of GoI’s letters of immunity and indemnity to the two Israeli banks offering clearing and settlement services is temporary.
  - GoI agreed in principle to take over clearing and settlement services via a new Israeli correspondent company; required Israeli legislation not yet adopted by the Knesset; company has not started due diligence on Palestinian banks pending agreement on scope.
  - Risks: potential disruption of correspondent banking relations, further asset quality deterioration, and financial stability implications.
- PMA actions and recommendations:
  - Strengthened macroprudential tools, crisis management arrangements, payment infrastructure, composite risk indicators, loan-to-value and loan-to-income caps, sectoral concentration limits, liquidity coverage and net stable funding ratio requirements, multi-factor stress testing with IMF support.
  - Recommended next steps: enhance stress testing methodologies (macroeconomic scenario analysis, satellite modeling of credit growth and NPLs); incorporate solvency stress tests into supervision and link to Pillar 2 capital add-ons; make on-site loan quality assessments more forward looking; operationalize emergency liquidity assistance; strengthen Palestine Deposit Insurance Corporation capacity, amend laws to reflect resolution role, raise premiums, automate payout processes.

### AML/CFT and CBRs progress
- MENFATF AML/CFT onsite assessment: onsite visit repeatedly delayed; no new dates identified.
- Palestinian interim actions: strengthening AML/CFT legislation; improving AML/CFT implementation; updating National Risk Assessment.
- Authorities’ stance: welcome IMF support on stress testing, onsite risk-based supervision, and bank resolution; PMA ready to work with BoI and other Israeli institutions to finalize and operationalize new shekel CBR mechanism.

### Structural reform priorities, digital agenda, and infrastructure
- Structural priorities to boost growth:
  - Ease Israeli-imposed restrictions on movement, access, and investment.
  - Allow Palestinian businesses access to and investment in Area C; IMF staff’s May 2022 Report to the AHLC estimate: could boost long-term annual growth potential by as much as 4 percentage points per year, to 6 percent.
- Domestic reforms and digital agenda:
  - 2021 companies law modernized framework for business registration and licensing; implementing regulations and digital infrastructure needed.
  - Need adoption of e-commerce and e-signature laws; better inter-agency coordination to boost digital entrepreneurship, digital financial services, and trade logistics.
  - Telecom: Telecom law amendments; understanding with GoI to allow Palestinian operators to use 4G spectra; GoI approval for fiber optic links and selection of Israeli operators still pending; technical/commercial agreements required.
  - Other laws: Cabinet-approved competition law not yet signed by the President; progress on labor law, consumer protection, insolvency and debt settlement laws at a standstill.
- Infrastructure and energy:
  - Large projects in electricity generation and transmission would materially benefit growth.
  - Palestine Investment Fund: investing in renewable and conventional power (e.g., Nablus and Araba solar power plants).
  - Constraints: significantly more generation capacity needed; construction in Area C of large-scale solar and transmission infrastructure held back by Israeli restrictions.
  - Gas for Gaza project: contingent on Israeli approval of pipeline crossing design; will allow Gaza Power Plant to switch from diesel to gas, increasing capacity and substantially reducing greenhouse gas emissions (GHGs).

### Staff appraisal, risks, and policy recommendations
- Staff appraisal:
  - Palestinian economy remains in a dire state amid volatile security, political, and social conditions; economic recovery gradually losing momentum; per capita income expected to gradually fall over the medium term; widening living standards gap between West Bank and Gaza.
  - Unresolved fiscal crisis and liquidity squeeze prompting month-to-month budget execution, undermining delivery of services and full payment of wages.
  - Continued accumulation of arrears, persistently high unemployment and poverty, and growing public discontent add to vulnerabilities; reform drive faltering.
- Priority policy recommendations:
  - For Israeli/PA/international coordination: ease restrictions on movement, access, and investment; resolve outstanding fiscal files including taxation in Area C.
  - PA domestic reforms: enhance business climate; advance digital transformation; step up critical energy infrastructure projects; trim the wage bill (top priority); reform net lending and health referrals; consider phased removal of fuel subsidies; ponder pension reform over the medium term.
  - International community: consider increasing grants from currently low levels to allow paced consolidation and protect vulnerable groups.
  - Financial sector and CBRs: PMA to continue closing gaps in risk-based supervision; operationalize new long-term CBR arrangements with Bank of Israel and relevant Israeli entities.

### Debt Sustainability Assessment (Annex II) — structure, projections, and risks
- Government debt composition and recent developments:
  - Domestic debt: 85 percent of total debt at end-2022.
  - Arrears: estimated 67 percent of total debt (estimate pending a dedicated audit).
  - Arrears largely to the pension fund, suppliers and contractors, and public sector employees (partial salaries since November 2021).
  - External debt: about 15 percent of total debt at end-2022; main external creditors include the Al Aqsa Fund, the World Bank, and Qatar National Bank; bilateral creditors (Italy and Spain) account for 11.5 percent of external debt.
- Selected historical debt indicators (percent of GDP): gross debt liabilities: 2019 34.5; 2020 47.1; 2021 50.2; 2022 49.1. Arrears: 2019 18.6; 2020 25.1; 2021 27.7; 2022 27.8.
- Baseline projections and trajectory:
  - Without policy changes, gross public debt projected to increase to about 64 percent of GDP by 2032.
  - Drivers: primary deficit and weak economic growth.
  - Baseline macro assumptions excerpt (memo):
    - Real GDP growth: 2022 3.9; 2023 3.0; 2024 2.7; 2025 2.4; 2026–2032 2.0 (each year).
    - Inflation (GDP deflator; percent): 2022 1.5; 2023 3.4; 2024 2.7; 2025 2.5; 2026–2032 2.0 (each year).
    - Effective interest rate (percent): 2022 1.6; 2023 1.7; 2024 1.8; 2025 2.1; 2026 2.6; 2027 3.0; 2028 3.5; 2029 3.9; 2030 4.2; 2031 4.5; 2032 4.7.
- Baseline public debt projections (percent of GDP, Actual and Projections):
  - 2022: 49.1; 2023: 47.9; 2024: 47.6; 2025: 47.9; 2026: 49.0; 2027: 50.4; 2028: 52.3; 2029: 54.3; 2030: 56.9; 2031: 60.1; 2032: 64.1.
- Gross Financing Needs (percent of GDP, baseline):
  - 2022: 4.6; 2023: 9.9; 2024: 12.3; 2025: 15.0; 2026: 17.4; 2027: 17.6; 2028: 18.2; 2029: 18.0; 2030: 20.2; 2031: 22.2; 2032: 22.5.
- Debt-service (percent of GDP):
  - 2022: 4.4; 2023: 9.5; 2024: 11.0; 2025: 13.5; 2026: 15.6; 2027: 15.7; 2028: 16.0; 2029: 15.9; 2030: 17.8; 2031: 19.3; 2032: 18.9.
- Near-term and medium-term risk assessment:
  - West Bank and Gaza already in debt distress; PA has been accumulating arrears since November 2021.
  - Fanchart width: 58.4, probability of debt not stabilizing: high (90.0 pct).
  - GFN module indicates moderate liquidity risks but may underestimate them due to political/social instability and limited financing options.
  - Contingent liabilities and larger-than-estimated arrears could push trajectories to the 75–95th percentile range and cause a permanent increase in debt and a spike in gross financing needs.
- DSA summary assessment:
  - Overall: High
  - Medium term: High
  - GFN: Moderate
  - Long term: High
  - Debt stabilization in the baseline: No
  - DSA Summary Assessment: Unsustainable
- Policy implication: Restoring debt sustainability requires coordinated transformative reform by the PA, Israel, and the international community, including larger grants by international donors.

### Risk Assessment Matrix — major risks and mitigation
- Further deterioration of the PA’s fiscal trajectory
  - Relative Likelihood: High
  - Expected Impact: High
  - Mitigation: Pursue gradual fiscal consolidation centered on expenditure reform and consolidation of revenue gains; take stock of arrears and devise credible repayment; ensure banking system well capitalized.
- Fiscal crisis spilling over to the banking sector
  - Relative Likelihood: Medium/High
  - Expected Impact: High
  - Mitigation: Reduce banks’ exposure to the PA; strengthen bank supervision and crisis management.
- Reduced financial services by Israeli correspondent banks
  - Relative Likelihood: High
  - Expected Impact: High
  - Mitigation: Adopt long-term alternative for current CBRs; strengthen AML/CFT framework; strengthen cross-border payment systems.
- Escalating social and security tensions
  - Relative Likelihood: High
  - Expected Impact: High
  - Mitigation: Sound macroeconomic management and reforms to instill confidence while recognizing limited ability of economic policies to resolve political discontent.
- Israel tightening movement restrictions
  - Relative Likelihood: Medium/High
  - Expected Impact: High
  - Mitigation: Seek additional grants to compensate associated hardship.
- Donor support decline
  - Relative Likelihood: High
  - Expected Impact: Medium
  - Mitigation: Pursue reform agenda to entice donors.
- Global risks: abrupt global slowdown (Medium/Medium); intensification of regional conflicts and commodity price volatility (High/Medium); extreme climate events (Medium/High).
  - Mitigation: Temporary targeted support if fiscal space allows; strengthen banking crisis management; strengthen disaster preparedness.

### Key selected fiscal and macro indicators (exact figures)
- Per capita GDP (2022 est.): US$3,569
- Poverty rate (2017 est.): 14 percent in the West Bank; 53 percent in the Gaza Strip
- Overall balance (commitment) (percent of GDP), 2019–28: -4.5 -7.4 -5.2 -1.0 -1.3 -2.2 -2.4 -2.8 -3.1 -3.4
- Nominal GDP (in millions of U.S. dollars), 2019–28: 17,134 15,532 18,109 19,112 20,355 21,469 22,533 23,490 24,439 25,426
- Total revenues and grants (percent of GDP), 2019–28: 23.9 25.7 25.6 29.3 29.0 28.4 28.4 28.5 28.5 28.5
- Total Expenditure and Net Lending (percent of GDP), 2019–28: 28.3 33.0 30.8 30.3 30.3 30.6 30.8 31.3 31.5 31.9
- Wages and salaries (percent of GDP), 2019–28: 10.9 12.9 13.3 13.1 13.3 13.5 13.6 13.8 14.0 14.2
- Grants (percent of GDP), 2019–28: 2.9 3.1 1.8 1.9 1.9 1.9 1.8 1.8 1.7 1.6
- Central government debt (incl. arrears) (percent of GDP), 2019–28: 34.5 47.1 50.2 49.1 47.4 47.4 47.1 47.3 48.2 49.4 50.9

### IMF technical assistance and capacity building (2019–23)
- TA areas: public financial management, revenue administration, banking regulation and supervision, stress testing, AML/CFT, national accounts, external sector statistics, macro-fiscal unit support, and national payments system development.
- Selected missions across fiscal, monetary/financial, and statistics areas from 2019 through 2023, supporting revenue administration, macro-fiscal capacity, stress testing, bank resolution, AML/CFT, national accounts, and statistics improvements.
- Commentary: Transparency and timeliness of data by Palestinian authorities are on par with good standards, but additional work needed to improve data consistency and produce quarterly and annual chain-linked national accounts.

*Source: International Monetary Fund — West Bank and Gaza: Recent Economic Developments and Outlook (extracts and IMF staff chapters).*

### 1.   Economic Divergence Between the West Bank and Gaza _____________________________________ 7

### 1.   Economic Divergence Between the West Bank and Gaza

### Recent economic developments and outlook
- Real GDP growth: 3.9 percent in 2022; projected 3 percent in 2023; converging to a 2 percent potential rate over the medium term.
- Inflation: projected at 3.4 percent in 2023 and 2 percent over the medium term.
- Current account deficit: widened to 15.0 percent of GDP in 2022 (from 9.8 percent in 2021).
- Imports: rose by 27.5 percent in 2022, contributing to the wider current account deficit.
- External balance drivers: substantial net income inflows partly offset trade deterioration due to a further increase in the number of Palestinian workers in Israel.
- Growth headwinds: deteriorating political, security, and social situation; lower growth in Israel; restrictions on movement of goods, people, and investment.

### Box 1 — Economic divergence between West Bank and Gaza: key facts
- Long-run outcomes:
  - Gaza per capita income: fell by an average of 2½ percent per year between 2007–22; by 2022 it stood at less than a third of that in the West Bank.
  - Gaza labor force unemployment: around 45 percent.
  - Population below national poverty line: Gaza 53 percent; West Bank 13 percent and 14 percent (two figures reported for West Bank poverty and unemployment respectively).
- Drivers and structural differences:
  - Gaza reliance: mainly government consumption; low investment concentrated in construction.
  - Capital stock: Gaza’s capital stock “now barely stands at its level of 15 years ago”; West Bank’s capital stock “more than doubling” over the same period.
  - Trade openness (sum of imports and exports over GDP): Gaza 61 percent; West Bank 91 percent.
- Preconditions for improvement:
  - Significant easing of restrictions on movement of goods, labor, and capital is stated as a necessary condition for higher growth in Gaza and positive spillovers for the West Bank.
  - Continued international donor support is essential to develop critical infrastructure (electricity generation and transmission; fresh and waste water) and reduce poverty.

### Fiscal sector and public finances
- 2023 budget and execution:
  - The 2023 budget projects the deficit to almost double to 1.9 percent of GDP in commitment terms.
  - Authorities are executing the budget on a month-to-month cash basis amid rising liquidity constraints.
  - The wage bill may exceed budgeted amounts following substantial 2023 wage hikes that more than undo potential savings from the 1-for-2 hiring rule.
  - Development expenditure is budgeted to double but financing assumes further substantial revenue gains and increased donor support.
- Clearance revenues and unilateral deductions:
  - Doubling of unilateral deductions from clearance revenues by the GoI under the 2018 Israeli Palestinian Prisoners Law in 2023H1.
  - The amount withheld since 2019 is estimated at US$786 million (4.4 percent of 2023 GDP).
- Arrears and public debt:
  - Estimated end-2022 stock of arrears: 27.8 percent of GDP.
  - Public debt (including arrears) projected to resume an increasing trend after a temporary decline; by 2028 public debt is projected at 51 percent of GDP, up from 49 percent in 2022.
- Fiscal risks and constraints:
  - No access to international capital markets; authorities are limiting bank borrowing to contain banks’ sovereign exposure.
  - Any shortfall in budget financing will likely translate into further buildup of domestic arrears.
  - Delivery of core government services at risk (education, health), with reported funding shortfalls and strikes affecting service provision.

### Financial sector developments and stability
- Capital, profitability, and liquidity:
  - Banks’ capital: 16.4 percent of risk-weighted assets at end-June 2023.
  - 2023Q2 profitability: 15 percent return on equity.
  - Liquidity: 40.3 percent of short-term liabilities.
- Excess physical shekel cash holdings:
  - Exceptional shipment authorized by the Bank of Israel reduced banks’ shekel holdings to NIS 5.1 billion (6.6 percent of total assets) at end-2023Q2.
  - Excess physical shekel holdings increased to NIS 6 billion by end-July 2023, raising security and insurance risks and costs.
  - Less than half the estimated NIS 1 billion that permitted Palestinian workers earn in Israel each month is currently paid through bank transfers.
- Asset quality:
  - Non-performing loans (NPLs): 4.1 percent of total loans at end-2023Q2.
  - Aggregate of NPLs, watchlist, substandard and doubtful loans: 11.1 percent by end-2023Q2.
- Exposure to the PA:
  - Banks’ direct exposure to the PA: 20 percent of total loans (about 11 percent of assets or 101 percent of equity) at end-June 2023.
  - Loans to PA employees add an additional 16 percent of loans (9 percent of assets) in indirect exposure.
  - Total exposure (direct and indirect) at 36 percent of total loans.
- Correspondent banking relations and financial stability risk:
  - Risks include potential disruption of correspondent banking relations and further asset quality deterioration.

### Downside risks
- Security and socioeconomic risks:
  - Escalation of tensions with Israel could prompt tighter restrictions on movement of labor, capital, and goods.
  - Persistently high unemployment and poverty (particularly in Gaza), weak public service delivery, arrears, and social dissatisfaction increase socio-political fragility.
- Donor support and reform appetite:
  - International donor support could decline further, constraining the PA’s room to maneuver and the pace of reforms.
- Banking-sector vulnerabilities:
  - High bank exposure to the PA, potential asset quality deterioration, and correspondent banking risks pose risks to financial stability.

### Policy priorities and reform recommendations
- Need for transformative reform:
  - A comprehensive package of fiscal and structural reforms by the PA is recommended to achieve higher growth and fiscal sustainability.
  - Easing Israeli-imposed restrictions on movement, access, and investment and resolving outstanding fiscal files with Israel are critical prerequisites.
  - Increased donor grants should be used to pace fiscal consolidation, protect the most vulnerable, and support critical infrastructure to foster private sector-led growth.
  - A political peace settlement is identified as the ultimate determinant of a fundamental change in prospects.
- Fiscal reform — revenue measures:
  - Continue the 2022–25 revenue strategy focused on expanding the tax base and strengthening tax compliance.
  - Implemented measures include:
    - e-VAT system (estimated yield of about 1 percent of GDP per year, pending further take-up from Israeli traders).
    - Establishment of new tax offices and increased field visits.
    - Coordination and connection of agencies, systems, and databases to foster automatic checks.
  - Complementary measures suggested:
    - A system for exchange of taxpayers’ bank information with the Ministry of Finance while safeguarding confidentiality and avoiding misuse.
    - A new VAT law awaiting the President’s signature; a new customs law draft being finalized; amendments to the income tax law to be addressed later.

*Source: International Monetary Fund — West Bank and Gaza: Recent Economic Developments and Outlook (extract).*

### 11.      Disputes over fiscal leakages with Israel are still awaiting resolution. Overall, fiscal

### 11.      Disputes over fiscal leakages with Israel are still awaiting resolution. Overall, fiscal

### Fiscal leakages and outstanding fiscal files
- Overall, fiscal leakages are estimated at around 1½ percent of GDP on an annual basis.
- Recent developments:
  - Halving of the handling fee charged on Palestinian fuel imports (to 1.5 percent).
  - Recent procedural progress with the Israeli legislation mandating the use of the e-VAT system for Israeli traders.
- Further tangible outcomes warranted on outstanding fiscal files, including:
  - (i) lowering the handling fees on imports, including doing away with them altogether on fuel, to make them commensurate with actual costs;
  - (ii) transferring to the PA the tax revenue on Israeli economic activity in Area C (outside settlements and military locations) in line with the Paris Protocol (Box 2);
  - (iii) fully sharing the Allenby bridge crossing fees; and
  - (iv) transferring customs authority to the PA.

### Box 2 — Taxation framework and responsibilities in Area C
- The Israeli-Palestinian Interim Agreement of 1995 (Oslo II Accord) established the framework for taxation of Area C.
- According to Annex III—the Protocol Concerning Civil Affairs—Israel is responsible for levying and collecting income tax (Appendix 1, Article 8) and VAT (Appendix 1, Article 18) on Israeli individuals and corporations in Area C—outside the settlements and military locations—and remitting the proceeds to the Palestinian side. Taxes should be levied and collected according to the Palestinian tax code and legislation.
- Israeli economic activities established in Area C outside the 1995 perimeter of settlements and military locations are significant (industrial parks, quarries, substantial agricultural businesses).
- The PA notes that no tax proceeds on these activities are being remitted from Israel to the PA.
- Area C context:
  - Area C is around 60 percent of the West Bank, is home to about 300,000 Palestinians and over 500,000 Israelis living in settlements (Office of the United Nations High Commissioner for Human Rights).
  - Area A: PA has full responsibility for internal security and public order, as well as civil affairs.
  - Area B: PA has full responsibility for civil affairs, while Israel has over-riding security authority.

### Authorities’ views on revenue strategy and outstanding fiscal files
- Authorities underline the continued success of their 2022-2025 revenue strategy, but point to limitations pending significant advancements on fiscal files with Israel.
- They stress:
  - Success of the e-VAT system, which could provide substantially higher yields if made mandatory for Israeli traders.
  - Once adopted, new customs, VAT, and income tax laws are expected to further expand the tax base and increase revenues.
- They emphasize that the overall margin for generating further revenue gains on top of those recently achieved are pending on the resolution of outstanding fiscal files with Israel (including on taxation of economic activity in Area C), while expressing skepticism on progress.
- They reiterate the need for enhanced transparency and accountability with regards to Israeli clearance revenues deductions for electricity, water (fresh and waste), and health referrals.

### Expenditure reform — Wage bill
- The public sector wage bill is large by international comparison:
  - In 2022, it stood at 43 percent of total spending, above the 90th percentile of the distribution of peer countries.
  - In the same year, the wage bill stood at 48 percent of total revenues excluding grants, or almost 90 percent of net revenues when including certain transfers that the authorities treat as part of their wage obligations and label as “semi-wages”.
- The significant increase over the last decade has mainly been driven by salary increases sustained by a generous system of allowances, rather than excessive employment.
- Authorities’ measures and implementation issues:
  - A high-level committee developed reform proposals.
  - Recent decisions include:
    - (i) re-deploy personnel across administrations and departments based on annual reviews of HR needs and skill mismatches, with the aim of addressing pockets of over-staffing and avoiding over-hiring;
    - (ii) hire only 1 new public employee for every 2 that leave public service.
  - Implementation of the 1-for-2 hiring rule is facing resistance citing the need to replace essential personnel, impairing potential savings.
  - Significant wage increases negotiated in early 2023 with the teachers’, doctors’, and engineers’ unions will further worsen the PA’s fragile fiscal position; possibility of new strikes calling for further wage increases would add to the pressure and cause more interruptions in essential public service delivery.
- Recommendations to control wage dynamics:
  - In the short term, consider temporarily suspending part of salary and allowance increases—particularly for public employees above a certain grade—as well as promotions.
  - In the medium term, pursue deeper reforms of the salary and allowance structure—including integration of allowances into base pay—and reform criteria and procedures for salary increases and promotions.
  - Measures should be part of a broad-based overhaul of the civil service, informed by a functional review to eliminate redundancies and inefficiencies.
  - If considering a new early retirement scheme, ensure it does not substitute for measures targeting underlying determinants of excessive wage bill growth or undermine productivity and pension sustainability.

### Pension system — features, risks, and reform
- Features and fiscal impact:
  - The public pension system is multifaceted and provides generous benefits across four schemes; only one continues to collect contributions.
  - Following transition, all active civil servants and security personnel are now covered by unified scheme II introduced in 2005; legacy schemes’ participants still account for the majority of current pensioners.
  - Public pension outlays are sizeable at around 4 percent of GDP, despite current beneficiaries representing only 1.5 percent of the population.
- Sustainability challenges and arrears:
  - De jure, scheme II includes a pre-funded defined-benefit (DB) component, but the PA has not been able to pay full contributions to the Palestinian Pension Agency (PPA).
  - Accumulated consequences include:
    - (i) a sizeable stock of arrears to the PPA (estimated at 14 percent of GDP in 2023);
    - (ii) invested pension fund assets far insufficient to meet future obligations.
  - Even if the PA clears all its arrears and remains current on future contributions, the system will likely require public support due to projected increases in life expectancy.
- Operational practice:
  - The PA remains current on its pension obligations by transferring monthly amounts needed to pay current pension outlays, meaning scheme II is de facto operated as a PAYGo system without a pre-funded component, creating discrepancy with the legal set-up and opaque cross-claims between the PA and PPA.
- Recommended measures to restore viability:
  - Align the de jure and de facto systems in the direction of a DB contributory PAYGo system (i.e., without pre-funding element) to enhance fiscal transparency, management, and predictability; stop further accumulation of PA contribution arrears and transform existing arrears into equivalent (in net present value terms) future budgetary obligations.
  - Implement parametric pension reform. Authorities should consider:
    - (i) gradually increasing mandatory and early retirement ages and indexing them to future increases in life expectancy;
    - (ii) reducing early retirement benefits;
    - (iii) revising the accrual rate;
    - (iv) modestly increasing the contribution rate.
  - Pair pension reform with ambitious expenditure reforms to put public finances on a sound footing.

### Other spending efficiency opportunities
- Address net lending:
  - Annual expense on net lending is projected to remain at almost 2 percent of GDP in 2023, broadly unchanged from previous years.
  - Authorities are finalizing a portal to facilitate monthly reconciliation of past cross-claims between the PA and Local Government Units (LGUs).
  - Reform options include replacing the system of intergovernmental offsets with one of fixed transfers, while increasing LGUs’ own resources and administrative capacities.
- Better targeting subsidies:
  - Despite lower fuel prices, untargeted and regressive fuel subsidies remain a significant fiscal cost at an estimated 0.9 percent of 2023 GDP.
  - In the medium term, authorities should consider gradually phasing them out and use part of the saved resources for better targeted social spending benefiting the most vulnerable households in both the West Bank and Gaza.
- Reforming the health referrals system:
  - Progress has been made in containing costs, including negotiating standardized prices with most Palestinian hospitals and enhancing system management through digitalization.
  - Medical referrals still account for more than ¾ of non-wage health spending.
  - Recommended reforms: alleviate capacity constraints of the public health system, prioritize investment in areas of care driving referrals, extend practice of negotiating service costs (including with Israeli hospitals), enhance coordination with Israeli system to reduce permit delays and denials, and increase transparency in deductions from clearance revenues due to referrals.

### Other fiscal issues and public financial management (PFM)
- Strengthening PFM would promote policy-based budget preparation and support fiscal reform efforts, including arrears management.
- With completion of the 2020-21 audit by the State Audit Bureau, the PA has improved timeliness of financial account audits.
- Once liquidity constraints ease, authorities should resume gradual transition toward a medium-term fiscal framework (MTFF) integrated with the budgetary process to incorporate medium-term fiscal risks and enhance credibility.
- Increasing accountability and transparency requires a comprehensive stocktaking of arrears and formulating a credible plan for their gradual repayment.
- The authorities continue to benefit from IMF capacity development in many of these areas.

### Authorities’ views on expenditure reform and constraints
- Authorities agree on need for deep expenditure reform but emphasize proceeding with caution given fragile context.
- Priority: containment of the wage bill to restore sustainability of public finances.
- Constraints:
  - Implementation of the 1-for-2 hiring rule faces resistance, particularly in essential public service sectors.
  - Limiting salary increases is difficult under rising social pressures.
  - Socio-political tensions impede open discussions on pension reform.
- On net lending and medical referrals, authorities note recent progress (increased collection rate of electricity bills, stricter spending controls, pilot project allowing five municipalities to collect property taxes) but stress liquidity squeeze restrains ability to finance needed reforms.

### Financial sector issues and PMA actions
- The Palestine Monetary Authority (PMA) has made significant progress bolstering its financial stability toolkit and should continue to strengthen its risk-based supervisory framework.
- Strengthening achieved:
  - Macroprudential tools, crisis management arrangements, and payment infrastructure have been strengthened.
  - Regulatory capital requirements: 13 percent of risk weighted assets, including a 2.5 percent capital conservation buffer.
  - Additional buffers (such as a domestic systemically important bank surcharge) have been introduced.
  - PMA developed composite risk indicators, improved risk assessment matrices and financial sector heat maps.
  - Implemented loan-to-value and loan-to-income caps, sectoral concentration limits, liquidity coverage and net stable funding ratio requirements.
  - Introduced multi-factor stress testing with IMF support.
- Recommended next steps:
  - Further develop stress testing methodologies to include more sophisticated macro-financial scenario analysis and satellite modeling of credit growth and NPLs.
  - Incorporate enhanced solvency stress tests into risk-based supervision and link results to supervisory actions, including Pillar 2 capital add-ons.
  - Make on-site loan quality assessments more forward looking; inspections should address credit, operational, liquidity, and market risks.
  - Operationalize emergency liquidity assistance.
  - Strengthen the Palestine Deposit Insurance Corporation’s capacity to backstop depositors and support crisis management by amending banking and insurance corporation laws to reflect the corporation’s role in resolution, raising premiums to strengthen long-term financial sustainability, and automating payout processes.

*Source: IMF staff report excerpts for West Bank and Gaza (provided content).*

### 24.       Progress in the development of a long-term alternative to the current CBR arrangements

### 24.       Progress in the development of a long-term alternative to the current CBR arrangements

### Progress on CBR (clearing and bank routing) and AML/CFT
- Progress in the development of a long-term alternative to the current CBR arrangements remains slow, while enhancements of the anti-money laundering and combating the financing of terrorism (AML/CFT) framework continue.
- The extension to end-March 2024 of the GoI’s letters of immunity and indemnity to the two Israeli banks that offer clearing and settlement services to Palestinian banks:
  - Is a welcome development but remains a temporary solution.
- Developments on an alternative shekel CBRs mechanism:
  - The GoI has agreed in principle to take over clearing and settlement services with all PMA-licensed Palestinian banks through its new Israeli correspondent company.
  - The company has an operational budget and has begun developing the necessary IT infrastructure.
  - Israeli legislation needed to:
    - establish the company’s mandate,
    - specify the precise nature of its relationship with the BoI and Palestinian banks,
    - secure its unencumbered access to the Israeli automatic clearing house,
    has not yet been adopted by the Knesset.
  - The company has yet to start its due diligence on Palestinian banks pending agreement on what it would entail.
- MENFATF AML/CFT onsite assessment:
  - The onsite visit by the MENFATF AML/CFT assessment team has repeatedly been delayed and no new dates for the visit have yet been identified.
- Palestinian authorities’ interim actions:
  - Strengthening AML/CFT legislation.
  - Continuing to improve AML/CFT implementation.
  - Updating their National Risk Assessment.

### Authorities’ views on supervision, AML/CFT, and CBRs
- Authorities concurred on the need to further strengthen the risk-based supervisory framework.
- Authorities pointed to a recent track record of sustained improvement in this area.
- Authorities welcomed additional IMF support on:
  - stress testing,
  - onsite risk-based supervision,
  - operationalization of the bank resolution framework.
- Authorities reiterated disappointment with repeated postponement of the MENAFATF onsite visit and are eager to have the visit take place as soon as possible; they have actively been seeking a new date.
- The PMA stands ready to work with the BoI and all other relevant Israeli institutions and entities to finalize and operationalize the new shekel CBR mechanism.
- Authorities continue improving their AML/CFT framework and its implementation with support from the IMF and the World Bank.

### Structural reform priorities and constraints
- Easing Israeli-imposed restrictions on the movement of goods and people and on investment remains critical to boost growth.
- IMF staff’s May 2022 Report to the AHLC estimate:
  - granting Palestinian businesses access to and allowing them to invest in Area C and easing trade restrictions could boost the Palestinian economy’s long-term annual growth potential by as much as 4 percentage points per year, to 6 percent.
- Recent GoI measures noted as welcome small steps:
  - measures facilitating the entry of good containers through the Allenby bridge,
  - continued expansion of the Door-to-Door (D2D) program.
- The D2D trade facilitation program:
  - allows Palestinian businesses to transport shipments from their production sites to recipients in Israel without undergoing the back-to-back transfer of shipments at dedicated but congested border crossings.
  - launched in 2018,
  - mostly benefits large enterprises, though Palestinian and Israeli authorities are working to expand services to more small and medium enterprises.

### PA domestic reforms and digital agenda
- Recent and pending reforms:
  - The 2021 companies law modernized the legal framework for business registration and licensing and strengthened minority investor protection.
  - Implementing regulations and new dedicated digital infrastructure (including an online business registration platform) are needed to maximize benefits and spur domestic private sector activity.
  - Digital economy and commercial law reform needed (examples):
    - adoption of e-commerce and e-signature laws,
    - better PA inter-agency coordination to boost digital entrepreneurship, digital financial services, and trade logistics.
  - Telecom sector:
    - Telecom law amendments strengthened the sector regulator’s technical and administrative powers.
    - An understanding with the GoI was reached to allow Palestinian operators to use 4G spectra, and the GoI selected a spectrum management company.
    - GoI approval for fiber optic links to ensure inter-city connectivity and selection of the Israeli operators with whom Palestinian operators will share spectra are still pending.
    - Technical and commercial agreements between Palestinian and the Israeli operators will subsequently need to be reached.
  - Other laws and legislative progress:
    - The Cabinet-approved competition law has not yet been signed by the President.
    - Progress toward adoption of the draft labor law, and the process of drafting consumer protection, insolvency and debt settlement laws are at a standstill.

### Infrastructure, energy, and growth implications
- Large infrastructure projects, particularly in electricity generation and transmission, would materially benefit economic growth.
- Palestine Investment Fund activities:
  - Spearheading large-scale investments in renewable and conventional power generation.
  - Financing innovative small- and medium-scale projects such as the Nablus and Araba solar power plants.
- Constraints and needs:
  - Significantly more generation capacity is needed to meet current electricity demand.
  - Construction in Area C of large-scale solar power plants and power transmission and distribution infrastructure is held back by Israeli restrictions.
- Gas for Gaza project:
  - Progress is contingent on Israeli approval of the final design of the pipeline crossing point into Gaza.
  - Upon completion, the project will allow the Gaza Power Plant to switch from diesel to more efficient and cleaner gas-powered electricity generation, increasing capacity and substantially reducing greenhouse gas emissions (GHGs).

### Authorities’ view on structural reform and Israeli role
- Authorities agree on the necessity for structural reforms in areas within the PA’s purview but underscore the role the GoI must play to foster growth.
- Authorities note several long-standing pieces of Palestinian legislation updated since 2021.
- Labor and social security legislation are pending consultation with the private sector.
- Authorities remain committed to drafting consumer protection, insolvency, and debt settlement laws with technical assistance from development partners, and to foster the digitalization of government services.
- Authorities stressed that Israel has an important role to play in boosting growth meaningfully by:
  - allowing Palestinians unhindered access to and investment in Area C,
  - reducing movement and access restrictions (including ending their blockade of Gaza),
  - enhancing cooperation and timely approval for large infrastructure projects.

### Staff appraisal: economic outlook and risks
- The Palestinian economy remains in a dire state amid a volatile security, political, and social situation, with downside risks persisting.
- Economic recovery is gradually losing momentum, reflecting the impact of the increasingly fragile environment and Israel’s sharp slowdown.
- Staff foresees a gradual reduction of real per capita income over the medium term amid a continued widening of the already large gap in living standards between the economies of the West Bank and Gaza.
- Under entrenched challenges and tight policy space:
  - The unresolved fiscal crisis and the liquidity squeeze have led the PA to execute the 2023 budget on a month-to-month cash basis, undermining delivery of basic government services, social support, and full payment of wages and salaries.
  - Continued accumulation of arrears, persistently high unemployment and poverty, and growing public discontent further add to vulnerabilities and social tensions.
  - The drive for much-needed reforms is faltering amid myriad challenges.

*Source: 24. Progress in the development of a long-term alternative to the current CBR arrangements*

### 31.      Achieving higher economic growth and overcoming the fiscal crisis are interrelated

### 31.      Achieving higher economic growth and overcoming the fiscal crisis are interrelated

### Growth and fiscal nexus: findings
- Easing the Israeli-imposed restrictions on movement, access, and investment would provide the largest boost to Palestinian economic growth.
- Following the halving of the handling fee charged by Israel on Palestinian fuel imports, further tangible outcomes on the resolution of the other outstanding fiscal files, including taxation in Area C, remains critical.
- Higher economic growth would greatly contribute to support public finances, but would not substitute for ambitious expenditure reforms needed to restore fiscal sustainability in a gradual and socially balanced way, while freeing up resources for much-needed development and social spending.

### Priority policy reforms and actions recommended
- For Israeli/PA/international coordination:
  - Ease restrictions on movement, access, and investment.
  - Resolve outstanding fiscal files, including taxation in Area C.
- PA domestic reforms:
  - Pursue reforms to enhance the business climate.
  - Advance the digital transformation of the economy.
  - Step up critical energy infrastructure projects.
  - Trim the wage bill (identified as the top priority expenditure reform).
  - Reform the systems of net lending and health referrals.
  - Gradually phase out fuel subsidies should be considered.
  - Over the medium term, ponder pension reform.
- International community:
  - Consider supporting the PA’s reform efforts by increasing grants from currently low levels, to allow a paced consolidation that would alleviate the burden on the most vulnerable.
- Financial sector and cross-border arrangements:
  - Building on recent progress in strengthening its financial stability toolkit, the PMA should continue working to close the remaining gaps in its risk-based supervisory framework.
  - The PMA, together with the Bank of Israel and other relevant Israeli institutions and entities, should operationalize new long-term CBR arrangements.

### Key fiscal and macro indicators (selected exact figures from tables and text)
- Per capita GDP (2022 est.): US$3,569
- Poverty rate (2017 est.): 14 percent in the West Bank; 53 percent in the Gaza Strip
- Overall balance (commitment) (percent of GDP), 2019–28: -4.5 -7.4 -5.2 -1.0 -1.3 -2.2 -2.4 -2.8 -3.1 -3.4
- Nominal GDP (in millions of U.S. dollars), 2019–28: 17,134 15,532 18,109 19,112 20,355 21,469 22,533 23,490 24,439 25,426
- Total revenues and grants (percent of GDP), 2019–28: 23.9 25.7 25.6 29.3 29.0 28.4 28.4 28.5 28.5 28.5
- Total Expenditure and Net Lending (percent of GDP), 2019–28: 28.3 33.0 30.8 30.3 30.3 30.6 30.8 31.3 31.5 31.9
- Wages and salaries (percent of GDP), 2019–28: 10.9 12.9 13.3 13.1 13.3 13.5 13.6 13.8 14.0 14.2
- Grants (percent of GDP), 2019–28: 2.9 3.1 1.8 1.9 1.9 1.9 1.8 1.8 1.7 1.6
- Central government debt (incl. arrears) (percent of GDP), 2019–28: 34.5 47.1 50.2 49.1 47.4 47.4 47.1 47.3 48.2 49.4 50.9

### Fiscal management and financing stance
- Ambitious expenditure reforms are needed to restore fiscal sustainability while protecting the vulnerable; trimming the wage bill is the top priority.
- In the absence of additional donor support, the projected financing gap will be closed through the accumulation of domestic arrears (tables note accumulation of new arrears under such circumstances).
- Identified financing and residual/financing gap lines show projected reliance on domestic financing and arrears accumulation under the baseline projections.

### Financial sector soundness (selected indicators)
- Tier I capital to risk-weighted assets: values around 15.5–16.6 (period coverage shown in table across 2017–2023).
- Nonperforming loans (percent of total loans): series includes 2.3 3.0 4.1 4.0 3.9 3.7 4.2 4.2 4.2 4.3 4.2 4.2 4.2 4.1 4.0 4.2 4.1 (as presented across dates).
- Coverage ratio (provisions as percent of nonperforming loans): series showing values including 58.4 86.2 75.0 ... up to values above 95.4 in later periods (table provides detailed quarterly values).
- Loan to deposit ratio: series around 65.5–70.4 across reporting dates.
- Return on assets (ROA): series showing values around 1.5 1.5 1.3 1.1 0.8 0.8 0.8 1.4 1.3 1.3 1.2 1.4 1.4 1.5 1.5 2.2 2.2 (table: Financial Soundness Indicators, 2017–23).

### Risk Assessment Matrix — major risks, likelihood, impact, and mitigation
- Further deterioration of the PA’s fiscal trajectory
  - Relative Likelihood: High
  - Expected Impact: High
  - If realized: Fiscal deficits widen, financed by an increasing stock of arrears; cascading arrears cause lack of confidence and all-round liquidity shortages, damaging growth and financial stability; debt (including arrears) remains unsustainable.
  - Policies to mitigate: Pursue gradual fiscal consolidation centered on expenditure reform and consolidation of revenue gains; take stock of arrears and devise a credible strategy to clear them; ensure the banking system remains well capitalized.
- Fiscal crisis spilling over to the banking sector
  - Relative Likelihood: Medium/High
  - Expected Impact: High
  - If realized: PA’s fiscal trajectory could hurt banks’ asset quality given banks’ high direct and indirect exposure to the PA, potentially undermining financial stability.
  - Policies to mitigate: Ensure banking system remains well capitalized; gradually reduce banks’ exposure to the PA; strengthen bank supervision and crisis management capacity.
- Reduced financial services by Israeli correspondent banks
  - Relative Likelihood: High
  - Expected Impact: High
  - If realized: Loss of Israeli-Palestinian correspondent bank relations would lead to trade and financial disruption and encourage a further shift into cash/informality, harming growth.
  - Policies to mitigate: Work with Israeli counterparts to adopt a long-term alternative for the current CBRs; strengthen the AML/CFT framework and build implementation capacity; strengthen cross-border payment systems.
- Escalating social and security tensions due to lack of opportunities or prospects for peace
  - Relative Likelihood: High
  - Expected Impact: High
  - If realized: Unemployment, poverty, and political frustrations may lead to civil unrest or confrontation, undermining growth and worsening the humanitarian crisis.
  - Policies to mitigate: Sound macroeconomic management and economic reform could help instill confidence and alleviate economic strain, though economic policies have limited ability to mitigate political discontent.
- Israel tightens restrictions on movement of goods and people further
  - Relative Likelihood: Medium/High
  - Expected Impact: High
  - If realized: Border closures or further constraints would hit growth hard and quickly; many Palestinian guest workers would lose jobs, reducing income transfers into WBG.
  - Policies to mitigate: Authorities could seek additional grants to partially compensate the population for associated hardship.
- Donor support remains low or declines further
  - Relative Likelihood: High
  - Expected Impact: Medium
  - If realized: Reduced support for poor and vulnerable households and makes reform implementation more difficult; given grants are at historic lows, further decreases would modestly worsen growth outlook.
  - Policies to mitigate: Pursue comprehensive reform agenda to improve macroeconomic situation and entice donors through increased grants.
- Global risks (abrupt global slowdown, intensification of regional conflicts, commodity price volatility, extreme climate events)
  - Relative Likelihood and Impact (as listed): Abrupt global slowdown — Medium likelihood, Medium impact; Intensification of regional conflicts and commodity price volatility — High likelihood, Medium impact; Extreme climate events — Medium likelihood, High impact.
  - If realized: Lower exports, slower growth, job losses, price volatility, social unrest, food and energy crises, damage to infrastructure, and financial instability.
  - Policies to mitigate: Provide temporary targeted support by shifting spending away from lower priority areas (if fiscal space allows); strengthen banking sector crisis management capacity; strengthen disaster preparedness and management capacity.

*Source: IMF staff chapter — “31. Achieving higher economic growth and overcoming the fiscal crisis are interrelated” (West Bank and Gaza).*

### Annex II. Debt Sustainability Analysis

### Annex II. Debt Sustainability Analysis

### Introduction
- The Sovereign Risk and Debt Sustainability Framework (SRDSF) assesses the risk of debt distress in the near (1–2 years) and medium term (5 years) and provides two outputs: a sovereign risk assessment and a debt sustainability assessment.
- The SRDSF includes “realism tools” to detect overly optimistic debt, fiscal and macroeconomic projections and combines mechanical outputs with IMF staff judgement.

### Structure of Government Debt and Recent Developments
- Government debt refers to central government liabilities, largely domestic.
- Key composition and creditor information:
  - Domestic debt stood at 85 percent of total debt at end-2022.
  - Arrears are estimated to be the largest component: 67 percent (estimate pending a dedicated audit).
  - Arrears are largely to the pension fund (unpaid government and employee contributions), PA suppliers and contractors, and public sector employees (partial salaries since November 2021).
  - Other domestic components: loans and overdrafts from commercial banks to the Palestinian Authority, promissory notes held by the private sector.
  - External debt represented about 15 percent of total debt at end-2022.
  - Main external creditors: the Al Aqsa Fund, the World Bank, and Qatar National Bank; bilateral creditors (Italy and Spain) account for 11.5 percent of external debt.

- Total Debt Liabilities of the PA (In percent of GDP) — selected series:
  - Gross debt liabilities: 2019 34.5; 2020 47.1; 2021 50.2; 2022 49.1
  - Domestic debt: 2019 27.6; 2020 39.1; 2021 43.1; 2022 41.7
  - Loans and overdrafts: 2019 8.9; 2020 14.0; 2021 13.5; 2022 12.9
  - Promissory notes 1/: ......2.0 1.0
  - Arrears 1/: 2019 18.6; 2020 25.1; 2021 27.7; 2022 27.8
  - External debt: 2019 6.9; 2020 8.0; 2021 7.0; 2022 7.5
  - 1/ Figures are estimates due to insufficient official data.

### Baseline Scenario Projections
- Macroeconomic outlook under unchanged policies:
  - Economic recovery losing momentum; growth projected to gradually converge to potential of around 2 percent over the medium term (below population growth).
  - Inflation forecasts settle at around 2 over the medium term.
  - Fiscal deficit estimated to rise to around 5.5 percent of GDP by the end of the SRDSF projection horizon.
  - Downside risks include escalation of security and political tensions, further increases of Israeli deductions from clearance revenues, and a larger-than-estimated stock of arrears.
- Financing and arrears dynamics:
  - New arrears expected to be accumulated over the medium term to cover financing gaps due to constrained budget financing options.
  - Domestic bank lending assumed limited because banks are already highly exposed to the PA.
  - The PA does not issue government securities in domestic or international markets.
  - Decreasing trend in budget support from the international community reinforces reliance on domestic arrears.
- Debt trajectory:
  - Without policy changes, gross public debt is projected to increase to about 64 percent of GDP by 2032.
  - Increase driven mainly by the primary deficit combined with weak economic growth; other drivers (real interest rates and inflation differential relative to the U.S.) play a modest role.

- Realism tools and projection scrutiny (summary of diagnostics):
  - Projections vs realizations: projected increase in debt is smaller than in the past; real GDP growth expected to bring down debt ratios more than in the past.
  - Optimism of debt projections: tool does not flag overoptimism concerns; projected three-year debt reduction is modest in cross-country and historical comparison.
  - Optimism of fiscal adjustment: staff projects a moderate fiscal relaxation; no overoptimism concerns signaled.
  - Consistency of fiscal adjustment and growth assumptions: baseline growth path broadly consistent with fiscal multipliers 0.5, 1, 1.5.
  - Optimism of baseline real GDP growth: projected GDP growth consistent with the 10-year average and potential growth; output gap close to zero after five years.

### Near-Term Risk Assessment
- West Bank and Gaza is already in debt distress.
- The PA has been accumulating arrears to the pension fund, suppliers, contractors, and to public sector employees since November 2021.

### Medium-Term Risk Assessment
- Debt evolution risks are significant:
  - Debt fanchart metrics (summarized):
    - Fanchart width for West Bank and Gaza: 58.4 (larger than the 75th percentile of comparators’ distribution), indicating considerable uncertainty.
    - Probability of debt not stabilizing: high and above the 75th percentile.
    - Terminal debt level interacted with an institutional quality index: between the 50th and 75th percentiles, suggesting low debt carrying capacity.
    - Combined Debt Fanchart Index (DFI) points to high solvency risks.
  - Implication: medium-term risks suggest need for deeper fiscal reforms than those in the baseline.
- Liquidity assessment:
  - Gross Financing Needs (GFN) module indicates moderate liquidity risks.
  - Rationale: most public debt is in domestic currency and nonmarketable; much debt is in the form of accounts payable (domestic arrears), providing some flexibility on repayment schedules.
  - Caveat: the GFN module may underestimate liquidity risks because it does not capture frequent political and social instability and limited financing options.
- Additional risks not fully captured:
  - Uncertainties over the size of accumulated arrears and limited central government coverage of official debt statistics.
  - Modeled as a contingent liability shock that, if materialized, would lead to a permanent increase in the stock of debt, pushing trajectories to the 75–95th percentile range and causing a temporary spike in gross financing needs that remains permanently higher.

### Debt Sustainability Assessment
- Overall assessment:
  - The large accumulation of arrears indicates that West Bank and Gaza is in debt distress.
  - Without PA adjustment policies and an easing of Israeli-imposed restrictions, public debt is unsustainable and projected to rise over the long term; accumulation of arrears likely to continue.
  - Restoring debt sustainability will require coordinated transformative reform by the Palestinian Authority, Israel, and the international community, including larger grants from international donors (as documented in IMF staff’s May 2022 Report to the AHLC).
- Summary diagnostic table (textualized):
  - Overall: High
  - Near term: n.a.
  - Medium term: High
  - Fanchart: High
  - GFN: Moderate
  - Long term: High
  - Debt stabilization in the baseline: No
  - DSA Summary Assessment: Unsustainable
- Commentary:
  - Restoring debt sustainability contingent on implementation of reforms, easing Israeli-imposed restrictions on movement and access to resources, and larger financial contributions by the international community.
  - Medium-term liquidity risks may be underestimated because of political uncertainty, social tensions, and limited access to financing options.
  - Over the longer run, West Bank and Gaza should continue reforms to generate jobs for a growing population and mitigate risks from climate change.
- Additional notes on risk drivers:
  - Medium-term risks arise from limited access to finance, Israeli restrictions on movement of goods, capital, and people, weak institutions, narrow debt coverage, weak subnational governments posing contingent liabilities, and political and social instability.
  - Long-term risks are high in the absence of political settlement, driven by lack of access to productive resources, uncertainty over economic reforms, and increasing climate change pressures.

*Source: IMF staff (Annex II. Debt Sustainability Analysis).*

### 4. Accounting principles:

### 4. Accounting principles

### Accounting framework and recording basis
- Commentary: Fiscal accounts for the central government include transfers to local government units and the pension fund.
- Government debt includes promissory notes and estimates of arrears to the private sector, pension fund, public sector employees and retirees.
- Comment: Domestic debt includes central bank advances, bank loans, loans from the Petroleum Authority and other public institutions, promissory notes, and estimates of arrears to the private sector, pension fund, public sector employees and retirees.

### Table notes and definitions
- CG=Central government; GG=General government; NFPS=Nonfinancial public sector; PS=Public sector.
- Stock of arrears could be used as a proxy in the absence of accrual data on other accounts payable.
- IPSGSs: Insurance, Pension, and Standardized Guarantee Schemes, typically including government employee pension liabilities.
- Non-cash basis: Includes accrual recording, commitment basis, due for payment, etc.
- Nominal value: "Nominal value at any moment in time is the amount the debtor owes to the creditor. It reflects the value of the instrument at creation and subsequent economic flows (such as transactions, exchange rate, and other valuation changes other than market price changes, and other volume changes)."
- Face value: "The face value of a debt instrument is the undiscounted amount of principal to be paid at (or before) maturity."
- Market value: "Market value of debt instruments is the value as if they were acquired in market transactions on the balance sheet reporting date (reference date). Only traded debt securities have observed market values."

---

### Public debt structure and indicators

### Holders, instruments, maturity, and currency (commentary)
- Perimeter shown is central government.
- Public debt by holder, by governing law, by instruments, by maturity, and by currency are presented for central government.
- Domestic debt includes central bank advances, bank loans, loans from the Petroleum Authority and other public institutions, promissory notes, and estimates of arrears to the private sector, pension fund, public sector employees and retirees.
- Commentary: Domestic debt composition and projections show interactions among domestic central bank, domestic commercial banks, domestic other creditors, external private creditors, and external official creditors.

---

### Baseline Scenario (Table 4): West Bank and Gaza

- Public debt (percent of GDP), Actual and Projections:
  - 2022: 49.1
  - 2023: 47.9
  - 2024: 47.6
  - 2025: 47.9
  - 2026: 49.0
  - 2027: 50.4
  - 2028: 52.3
  - 2029: 54.3
  - 2030: 56.9
  - 2031: 60.1
  - 2032: 64.1

- Change in public debt (percent of GDP):
  - 2022: -1.0
  - 2023: -1.3
  - 2024: -0.2
  - 2025: 0.3
  - 2026: 1.1
  - 2027: 1.4
  - 2028: 1.8
  - 2029: 2.1
  - 2030: 2.6
  - 2031: 3.2
  - 2032: 4.0

- Contribution of identified flows (percent of GDP):
  - 2022: -1.4
  - 2023: -1.8
  - 2024: -0.3
  - 2025: 0.2
  - 2026: 1.0
  - 2027: 1.4
  - 2028: 1.9
  - 2029: 2.1
  - 2030: 2.6
  - 2031: 3.2
  - 2032: 4.0

- Primary deficit 1/ (percent of GDP; measured on a commitment basis):
  - 2022: 0.2
  - 2023: 0.4
  - 2024: 1.3
  - 2025: 1.4
  - 2026: 1.8
  - 2027: 1.9
  - 2028: 2.1
  - 2029: 2.1
  - 2030: 2.5
  - 2031: 3.0
  - 2032: 3.6

- Noninterest revenues (percent of GDP):
  - 2022: 28.2
  - 2023: 28.1
  - 2024: 27.6
  - 2025: 27.6
  - 2026: 27.6
  - 2027: 27.6
  - 2028: 27.6
  - 2029: 27.8
  - 2030: 27.8
  - 2031: 27.8
  - 2032: 27.7

- Noninterest expenditures (percent of GDP):
  - 2022: 28.4
  - 2023: 28.6
  - 2024: 28.9
  - 2025: 29.0
  - 2026: 29.4
  - 2027: 29.5
  - 2028: 29.8
  - 2029: 29.9
  - 2030: 30.2
  - 2031: 30.7
  - 2032: 31.3

- Automatic debt dynamics (percent of GDP):
  - 2022: -1.6
  - 2023: -2.3
  - 2024: -1.6
  - 2025: -1.2
  - 2026: -0.8
  - 2027: -0.5
  - 2028: -0.3
  - 2029: -0.1
  - 2030: 0.1
  - 2031: 0.2
  - 2032: 0.4

- Real interest rate and relative inflation (percent):
  - 2022: -0.3
  - 2023: -0.8
  - 2024: -0.4
  - 2025: -0.1
  - 2026: 0.2
  - 2027: 0.5
  - 2028: 0.7
  - 2029: 1.0
  - 2030: 1.2
  - 2031: 1.4
  - 2032: 1.6

- Real interest rate (percent):
  - 2022: 0.0
  - 2023: -0.8
  - 2024: -0.4
  - 2025: -0.2
  - 2026: 0.2
  - 2027: 0.5
  - 2028: 0.7
  - 2029: 0.9
  - 2030: 1.2
  - 2031: 1.4
  - 2032: 1.6

- Relative inflation 2/ (inflation differential between West Bank and Gaza and the US):
  - 2022: -0.3
  - 2023: 0.0
  - 2024: 0.0
  - 2025: 0.0
  - 2026: 0.0
  - 2027: 0.0
  - 2028: 0.0
  - 2029: 0.0
  - 2030: 0.0
  - 2031: 0.0
  - 2032: 0.0

- Real growth rate (percent):
  - 2022: -1.9
  - 2023: -1.4
  - 2024: -1.3
  - 2025: -1.1
  - 2026: -0.9
  - 2027: -1.0
  - 2028: -1.0a.
  - 2029: -1.0
  - 2030: -1.1
  - 2031: -1.1
  - 2032: -1.2

- Real exchange rate:
  - 2022: 0.6

- Other identified flows, Contingent liabilities, Other transactions (percent of GDP):
  - All entries 2022–2032: 0.0

- Contribution of residual (percent of GDP):
  - 2022: 0.4
  - 2023: 0.6
  - 2024: 0.1
  - 2025: 0.1
  - 2026: 0.1
  - 2027–2032: 0.0

- Gross financing needs (percent of GDP):
  - 2022: 4.6
  - 2023: 9.9
  - 2024: 12.3
  - 2025: 15.0
  - 2026: 17.4
  - 2027: 17.6
  - 2028: 18.2
  - 2029: 18.0
  - 2030: 20.2
  - 2031: 22.2
  - 2032: 22.5

- Of which: debt service (percent of GDP):
  - 2022: 4.4
  - 2023: 9.5
  - 2024: 11.0
  - 2025: 13.5
  - 2026: 15.6
  - 2027: 15.7
  - 2028: 16.0
  - 2029: 15.9
  - 2030: 17.8
  - 2031: 19.3
  - 2032: 18.9

- Local currency (percent of GDP):
  - 2022: 4.2
  - 2023: 9.3
  - 2024: 10.8
  - 2025: 13.4
  - 2026: 15.5
  - 2027: 15.6
  - 2028: 15.9
  - 2029: 15.8
  - 2030: 17.7
  - 2031: 19.2
  - 2032: 18.8

- Foreign currency (percent of GDP):
  - 2022–2032: 0.1 (each year)

- Memo:
  - Real GDP growth (percent):
    - 2022: 3.9
    - 2023: 3.0
    - 2024: 2.7
    - 2025: 2.4
    - 2026: 2.0
    - 2027: 2.0
    - 2028: 2.0
    - 2029: 2.0
    - 2030: 2.0
    - 2031: 2.0
    - 2032: 2.0
  - Inflation (GDP deflator; percent):
    - 2022: 1.5
    - 2023: 3.4
    - 2024: 2.7
    - 2025: 2.5
    - 2026: 2.2
    - 2027: 2.0
    - 2028: 2.0
    - 2029: 2.0
    - 2030: 2.0
    - 2031: 2.0
    - 2032: 2.0
  - Nominal GDP growth (percent):
    - 2022: 5.5
    - 2023: 6.5
    - 2024: 5.5
    - 2025: 5.0
    - 2026: 4.2
    - 2027: 4.0
    - 2028: 4.0
    - 2029: 4.0
    - 2030: 4.0
    - 2031: 4.0
    - 2032: 4.0
  - Effective interest rate (percent):
    - 2022: 1.6
    - 2023: 1.7
    - 2024: 1.8
    - 2025: 2.1
    - 2026: 2.6
    - 2027: 3.0
    - 2028: 3.5
    - 2029: 3.9
    - 2030: 4.2
    - 2031: 4.5
    - 2032: 4.7

- Commentary: Weak economic growth combined with persistent primary deficits drive the steady increase of public debt over the medium and long term.

---

### Realism of Baseline Assumptions (Table 5)

- Commentary: Spreads to US treasury are not very relevant since West Bank and Gaza does not have market access.
- Commentary: The three-year debt reduction and projected fiscal adjustment are within norms.
- Commentary: Comparators may not be suitable because of West Bank and Gaza's special circumstances.
- Note 1/: Relative inflation refers to the inflation differential between West Bank and Gaza and the US.
- Note 2/: The Laubach (2009) rule: a linear rule assuming bond spreads increase by about 4 bps in response to a 1 ppt increase in the projected debt-to-GDP ratio.

---

### Medium-Term Risk Analysis (Table 6)

- Key indicators and values:
  - Fanchart width: 58.4 0.8
  - Probability of debt not stabilizing (pct): 90.0
  - Terminal debt level x institutions index: 36.6 0.8
  - Debt fanchart index: ...2.4
  - Average GFN in baseline: 15.1 5.1
  - Bank claims on government (pct bank assets): 10.8 3.5
  - Chg. in claims on govt. in stress (pct bank assets): 19.2 6.4
  - GFN financeability index: ...15.0

- Probabilities (2023-2028):
  - Prob. of missed crisis, 2023-2028 (if stress not predicted): 54.5 pct.
  - Prob. of false alarm, 2023-2028 (if stress predicted): 9.1 pct.

- Commentary: While the Debt Fanchart Module points to a high level of risk, the GFN Financeability Module indicates a moderate level of risk.
- Commentary: Gross financing needs may be underestimated because it is unclear if the private sector will accept continued accumulation of arrears.
- Commentary: Gross financing needs may be underestimated because of contingent liabilities from local governments and the pension fund.
- Commentary: Data on amortization are estimates.

---

### IMF Technical Assistance to the Palestinian Authority, 2019–23 (Annex III)

### Overview
- TA areas: public financial management (PFM), revenue administration, banking regulation and supervision, stress testing, anti-money laundering and combating the financing of terrorism (AML/CFT), national accounts, external sector statistics, macro-fiscal unit support.
- Priorities for medium-term capacity building: banking supervision, development of the national payments system, AML/CFT, periodic review and assistance to improve external sector and national accounts statistics.
- Departments providing TA: LEG, MCM, STA, with METAC support. FAD re-assessing fiscal TA needs and stands ready to deliver TA on expenditure reform, taxation, macro fiscal planning and cash management.

### Fiscal sector TA (selected missions and reports)
- February 17–28, 2019: Supporting the Development of the Macro-Fiscal Unit’s Capacity — April 2019.
- March 10–21, 2019: Revenue Administration/Large Taxpayer Office — March 2019.
- February 18–25, 2022: Training on Improving Tax Compliance in Digital Economy — n.a.
- March 14–17, 2022: Virtual Regional Workshop on Public Sector Debt Statistics — n.a.
- May 10–June 7, 2022: Review of Revenue Administration Reform Strategies — September 2022.
- June 7–12, 2022: Strengthening Macro Fiscal Planning and Quarterly Reporting — September 2022.
- November 27–December 9, 2022: Improving Compliance in the Large Taxpayer Department — n.a.
- May 30–June 5, 2023: Strengthening Fiscal Strategy — n.a.

### Monetary and financial systems TA (selected missions and reports)
- March 3–7, 2019: CFT framework — n.a.
- March 24–28, 2019: Basel III — n.a.
- December 3–12, 2019: FSSR Follow-up: Contingency Planning for Crisis Preparedness and Management* — July 2020.
- January 3–31, 2021: FSSR Follow-Up: Financial Institution Restructuring & Resolution — July 2021.
- April 26–May 6, 2021: Macro Stress-Testing — n.a.
- June 18–September 29, 2021: Macro Stress-Testing* — December 2021.
- May 3–7, 2021: FSSR Follow-Up: Financial Institution Restructuring & Resolution — July 2021.
- January 9–February 6, 2022: Developing a Crisis Management Plan* — May 2022.
- March 2–17, 2022: Bank Resolution Law Reform* — n.a.
- March 21–April 29, 2022: National Payment Systems — August 2022.
- May 8–11, 2022: AML/CFT* — December 2022.
- June 26–July 5, 2022: Strengthening On-Site Risk Based Supervision — October 2022.
- May 10–June 8, 2023: Operationalization of the Bank Resolution Regime — n.a.
- June 14–July 11, 2023: Assessment of Internal Audit Function — n.a.
- June 18–July 3, 2023: IFRS9 Implementation Review — n.a.
- July 9–18, 2023: Cyber Strategy and Supervisory Framework — n.a.
- September 12–25, 2023: In-Depth Assessment of Internal Audit Function — n.a.

(* Reports classified as confidential or strictly confidential.)

### Statistics TA (selected missions and reports)
- February 10–14, 2019: National Accounts — April 2019.
- December 13–15, 2019: National Accounts — February 2020.
- June 8–11, 2020: Residential Property Price Indices — August 2020.
- August 9–13, 2020: Compilation of Input-Output Tables — September 2020.
- February 21–25, 2021: Re-Chain Linking the National Accounts — April 2021.
- August 22–September 2, 2021: Institutional Sector Accounts – Sequence of Accounts — November 2021.
- February 27–March 10, 2022: Institutional Sector Accounts – Sector Accounts — April 2022.
- June 26–July 7, 2022: External Sector Statistics — August 2022.
- July 24–August 4, 2022: Annual National Accounts — October 2022.
- October 2–13, 2022: GDP – Administrative Data Sources — December 2022.
- August 13–24, 2023: GDP – Chain-linking — n.a.

- Commentary: Transparency and timeliness of data by the Palestinian Central Bureau of Statistics, the Ministry of Finance, and the Palestine Monetary Authority are on par with countries that maintain good data management and dissemination standards, but additional work is needed to improve data consistency in ESS and produce quarterly and annual chain-linked national accounts.

*Source: IMF staff.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1wbgea2023003.pdf_