Press Release No. 22/292

IMF Staff Concludes Visit to West Bank and Gaza

August 29, 2022

• The Palestinian economy experienced a strong post-COVID rebound in 2021, but unemployment and poverty remain persistently high. Economic growth is expected to moderate this year.
• The economy is facing formidable challenges that require comprehensive and coordinated reform. Efforts are required from the Palestinian Authority, Israel, and the donor community.
• The mission is encouraged by the authorities’ ambitious reform goals, centered on containing the public sector wage bill.

Washington, DC: An International Monetary Fund (IMF) staff team led by Mr. Alexander Tieman held discussions from August 16–28, 2022, to assess recent economic developments in the West Bank and Gaza. The IMF team met with Prime Minister Mohammad Shtayyeh, Finance Minister Shukry Bishara, Palestine Monetary Authority Governor Feras Milhem, Minister of National Economy Khalid Al-Esseily and other members of the Palestinian economic team.

At the end of the mission, Mr. Tieman issued the following statement:

“ The Palestinian economy experienced a strong rebound from the COVID-19 pandemic in 2021, but unemployment edged up and remains very high, in Gaza in particular. After a sharp recession in 2020, real GDP grew by 7.1 percent in 2021 as COVID vaccinations took off and movement restrictions were eased. Private consumption contributed 5.5 percentage points to growth, helped in part by higher employment of Palestinian workers in Israel. Growth in Gaza, however, was only 3.4 percent as reconstruction efforts following the May 2021 conflict advanced only slowly. Even as employment grew by 8 percent during the year, the unemployment rate increased to 26.4 percent at end-2021. The unemployment rate in Gaza remains stubbornly high, reflecting restrictions on movement of people and goods, and is closely associated with a high prevalence of poverty.

“The outlook for 2022 points to a slowdown of the economy amid rising inflation concerns. Growth is projected to decline to 4 percent, driven by lower consumption and investment due to lower real incomes as prices rise, continued fiscal weaknesses, and increased uncertainty related to Russia’s invasion of Ukraine—while direct spillovers from Russia and Ukraine are limited, indirect exposures, particularly on food and fuel imports via Israel, are substantial. Inflation is projected to rise significantly, driven by higher food, fuel, and construction material prices.

“Despite a difficult environment, the authorities contained the fiscal deficit. The fiscal deficit declined to 5.2 percent of GDP in 2021 and 0.4 percent of GDP in the first half of 2022. Going forward, the mission expects the deficit to rise in the second half of the year to reach 3.5 percent of GDP at end-2022. Contributing to these outcomes are large increases in revenues, well above nominal GDP growth, and restrained recurrent spending. This, however, also includes undesirable cuts to social transfers and low development spending. With 2021 budget grants down 40 percent from 2020, government debt (including arrears to suppliers and the Palestinian Pension Agency) increased from 34.5 percent of GDP in 2019 to 48.4 percent of GDP at end 2021, or 20.6 percent of GDP excluding arrears. Meanwhile, the banking sector remained stable, with adequate capital.

“The Palestinian economy is facing formidable challenges. The fiscal situation, high political, security and social tensions, rising inflation, movement and access restrictions and an unfinished structural agenda all weigh on the medium-term outlook. The fiscal challenges are largely structural in nature—the PA faces a high public sector wage bill and spends a considerable part of its budget in Gaza and East Jerusalem, but raises virtually no revenue in these areas or in West Bank areas under Israeli civil and security control, known as Area C, and the PA and Israel disagree on the amounts of revenue that the latter should transfer to the former. Without fiscal policy changes, public finances remain unsustainable and medium-term economic growth is expected to gradually slow down to its estimated potential rate of 2 percent.

“Overcoming these challenges will require ambitious reforms spanning several years and close cooperation between the Palestinian Authority, the Government of Israel, and donors. The PA needs to implement spending reform—centered on the wage bill, net lending and health sector reform—, further broaden its tax base, and undertake structural reform to improve the business environment. Working together, Israeli and Palestinian authorities would need to resolve outstanding fiscal files to boost Palestinian revenue and ease Israeli restrictions on the movement of goods and people and on investment to unleash the economy’s growth potential. Boosting confidence through the implementation of Palestinian-led reforms could attract donor funds, easing the adjustment burden on the population and private sector companies and thus helping pave the way for faster economic growth, job creation and poverty alleviation. In this regard we welcome the recent receipt of the EU’s 2021 donor funds.

“The mission is encouraged by the authorities’ well-justified reform goals. Their objective to significantly reduce the public sector wage bill and address net lending, pursue health care reform and improve the business environment will, over time, create fiscal space to clear arrears, increase social spending, and invest in development. It would also allow for the resumption of payment of full public sector wages, rather than the current practice of paying partial salaries—a temporary fiscal emergency measure, driving home the need for reform. The mission understands detailed plans for wage bill reform centered on early retirement are under development. This is an important first step that should be followed by policies to contain the wage bill going forward, including curtailing new hiring and wage increases, reforming the system of allowances, and, over the medium term, undertaking a functional review of public sector employment. The mission also discussed initiatives to contain net lending and reform the health sector. The mission welcomed the Ministry of Finance’s initiatives on all these reforms. For the reforms, the approach should be to first focus on “stop gap” measures that can be implemented in the short term, followed by a gradual and carefully sequenced implementation of ambitious medium term reforms, which will require strong sustained political commitment. In addition to these fiscal reforms, the Palestine Monetary Authority is leading the efforts to strengthen the anti-money laundering and countering terrorism financing (AML/CFT) framework in the Palestinian territories in line with international best practice, including through recent amendments to the AML/CFT law that criminalize terrorism financing and a decree that transcribes terrorism financing-related UN security resolutions into national legislation. The IMF stands ready to provide technical assistance to support the authorities’ reform efforts.

“ The mission encourages further progress on Israeli-Palestinian cooperation. It notes the positive economic impulse from the increased number of permits for Palestinians to work in Israel and settlements. The mission also saw progress on the e-VAT pilot, which should be expanded expeditiously to include all traders. It is further encouraged by the initiative to start paying Palestinian workers in Israel and settlements electronically, which will diminish the inflow of physical shekel cash into the West Bank and the Gaza Strip, thus reducing the excess cash problem faced by Palestinian banks. However, progress on the outstanding fiscal files has been slow since the May meeting of the Ad Hoc Liaison Committee. The mission urges the parties to quickly agree on lowering handling fees and exempting fuel shipments from them, while not losing focus on other fiscal files such as the Allenby (King Hussein) bridge fees and taxes from Area C, as well as the transfer of customs authority (including bonded warehouses). Likewise, only limited progress has been seen on resolving the longstanding and critical issue of correspondent banking relations. Intensified discussion between the Israeli and Palestinian Ministries of Finance could help advance these fiscal issues, while a broader discussion on trade and access should take place in a meeting of the Joint Economic Committee.

“The IMF team is grateful for the open and constructive discussions with the Palestinian authorities , as well as representatives from the government and central bank of Israel, the private sector, and the international community, which have enriched our understanding of the situation. The team will remain closely engaged to help the authorities address the economic and financial challenges.”