Bassam Aoun
Last updated: 15 May, 2013

Palestine gears up for battle with its own finances

The road forward for the Palestinian economy will be a bumpy ride, warns Bassam Aoun who covers public finance for Your Middle East.

The laundry list of policy issues and challenges that the Palestinian authorities have had to handle grew significantly last month as it added a hefty item to the agenda: the election of a prime minister. After months of tension and ardent disagreement over what direction to steer the state, former Palestinian Authority Prime Minister Salam Fayyad presented his resignation to President Mahmoud Abbas, bringing their impasse to an unfavorable end.

The resignation was detrimental to regional peace talks, which are currently undergoing a political resuscitation spearheaded by Secretary of State John Kerry. The decision not only left these parties frustrated at the prospect of carrying forward without Fayyad’s credibility in the international arena, but it also laid out a rough path for Palestinian finances.

Late last year, the United Nations voted to upgrade Palestine’s status to non-member observer state, and was at the time considered a significant victory for the delegation and its people. Although celebrations were abound, policymakers were anticipating a backlash from authorities who disagreed with the unilateral move, namely Israel and the United States. As expected, the Israeli state moved to withhold tax revenues intended for the Palestinian Authority, while the US virtually halted its financial aid packages in protest of the UN decision. The PA was pushed deeper into fiscal distress, with public sector wages remaining unpaid and consumer prices beginning to rise. Although the sanctions that were imposed have generally been lifted, their effects are still resonating in the West Bank and Gaza Strip.

The matter of fact is that the Palestinian Authority’s balance sheets were not in a position to weather such a liquidity drain, a certainty on multiple fronts. Recent measures of the budget deficit estimate it to be approximately $1.7 billion, or 17.1% of gross domestic product. The financial sanctions on the fiscal system resulted in an additional $570 million of debt diluted into the Authority’s substantial budget deficit. The total amount owed to the domestic banking sector received an increment of approximately $300 million, increasing the original figure from $1.1 billion in December 2011 to $1.4 billion one year later. Another point of concern is salaries in the public sector; non-wage recurrent spending, such as pension payments and healthcare, was over 16% above what was originally budgeted by policymakers. Even though the wage bill was on par with projected expenditures, the hostilities in the Gaza Strip during November of last year required an increase in social assistance expenses and aid, both of which are considered non-wage recurrent spending.

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Additionally, not only is the drain on the budget taking a hefty toll on Palestinian finances, but the taxation system is still under a microscope – authorities are in the process of reforming collection mechanisms and enhancing compatibility with Israeli financial regulations. Modifications have been suggested, discussed, and approved by the involved parties, such as an increase of half a percentage point in the value-added tax rates. A comprehensive implementation of the proposed changes, however, remains to be achieved. It may even have to take a backseat to ensuring electoral harmony in the state.

As of earlier this year, policymakers have set out a fiscal plan for 2013, where they intend on decreasing the current budget deficit to $1.3 billion, or just under 12% of the gross domestic product. Authorities in the administration are adamant that donor aid will regain traction this year, predicting it will reach $1 billion. This will leave a gap of $0.4 billion, in addition to other wage-related debts from the year prior, to be financed via disparate policies and initiatives. With robust efforts in ameliorating the state of the taxation system as well as other fiscal measures, the Palestinian state is gearing itself for a battle with its own finances.

All in all, the Palestinian Authority received a total of approximately $800 million in budgetary support since last year – closer to $1 billion was expected. While the health of its public finances is significantly contingent on the level of foreign aid the territories receive, its policymakers have nevertheless been able to devise methods to curb the effects of noxious influences.

The government’s ability to work under these stringent conditions is symbiotic of the nation’s capabilities. These have recently been embodied by a burgeoning IT sector in the West Bank and an increasingly educated youth faced with a lack of opportunity. It is no secret that policymakers, several times in coordination with external advisors, are doing all they can to alleviate their budget of its troubles. However, with external shocks such as the repercussions from the United Nations status upgrade, the comprehensive embargo imposed on the Gaza Strip, or the most recent exit of a high ranking official, these efforts may soon begin to witness a drop in efficacy.