OREANDA-NEWS. February 12, 2016. International Monetary Fund (IMF) mission led by Christoph Duenwald visited East Jerusalem and Ramallah from February 311, 2016, to assess recent economic developments in the West Bank and Gaza and the financial situation of the Palestinian Authority (PA). The mission met with Prime Minister Rami Hamdallah, Finance Minister Shukry Bishara, Governor Azzam Shawwa, Minister of National Economy Abeer Odeh, and other Palestinian officials.

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

2015 was another difficult year for the Palestinian economy. Growth in the West Bank slowed to an estimated 2.8 percent, as investment remained weak, donor aid declined sharply, and the suspension of clearance revenue transfers in the early part of the year undermined confidence. While reconstruction efforts following the Israel-Hamas conflict in 2014 provided some boost to the Gazan economy, the pace of recovery was hampered by slow aid disbursements and restrictions on imports of construction materials, and the humanitarian situation remains dire. Unemployment remains stubbornly high in the West Bank and higher still in Gaza, where two-thirds of young people are without a job.

In the face of the challenging circumstances, the authorities managed economic policies well, reducing the overall deficit for the third consecutive year. We estimate that the fiscal deficit declined by close to one percentage point of GDP, reflecting strong revenue performance and successful efforts to contain spending on the wage bill and in non-priority areas. However, efforts to alleviate social hardship in Gaza necessitated higher-than-budgeted spending on fuel. A sharp drop in donor aid contributed to higher public debt, including arrears. Nevertheless, the authorities managed to clear some arrears to the private sector and contributed small amounts to the Pension Fund on a monthly basis.

Uncertainty continues to cloud the economic outlook. Assuming that political uncertainty and Israeli restrictions persist, but that recent episodic violence does not escalate dramatically, GDP growth in the West Bank and Gaza will likely reach 3.3 percent in 2016, with sub-3 percent growth in the West Bank and 5 percent growth in Gaza reflecting continued rebuilding. Over the medium term, growth is projected to hover around 3.5 percent, leading to stagnant per capita incomes and rising unemployment. Also, real GDP in Gaza will not likely return to pre-conflict levels before 2018. While a breakthrough in national reconciliation efforts could set the stage for more favorable conditions, the main risksescalating violence that precipitates a security crisis; shortfalls in donor aid or revenue; or further spending pressures including in Gazawould diminish growth if realized.

The authorities have prepared a prudent 2016 budget focused on further revenue mobilization and spending controls, while increasing transfers to the Pension Fund to make the pension system more sustainable. Still, assuming donor aid around the same level as 2015, IMF staff estimates that the budget implies a large financing gap of over \\$500 million. To prevent arrears accumulation, the authorities are advised to take measures to narrow the gap, such as containing the increase in the wage bill to below 2 percent. However, as measures alone will not close the gap, increased donor aid will be critical in the year ahead.

Close monitoring will help ensure the continued health of the banking sector. While NPLs are among the lowest in the region, banks high exposure to the PA and double digit private sector credit growth in a weak economic environment warrant close attention. In particular, with most credit channeled to real estate, construction and consumption, the Palestine Monetary Authority should stand ready to deploy macro-prudential tools to address potential risks should they materialize. The recently approved Anti Money Laundering and Terrorism Financing law, in line with Financial Action Task Force guidelines, is a testament to the PAs determination to preempt risks and adhere to international best practices in this area.

Reforms to strengthen institutions and a more strategic approach to aid management, better aligned with budget priorities, will provide a stronger foundation for growth and donor engagement. Finalizing a new public financial management strategy to complement the 201722 National Policy Agenda will ensure that policy priorities are integrated into the budget. Other important milestones for 2016 include operationalizing the Public Procurement Council, approving the Secured Transactions and Companies laws, and completing the 2011 audited financial statements.

Despite the increasingly precarious political situation, enhanced economic cooperation between the PA and Government of Israel is critical to improve the prospects for fiscal sustainability and economic development. A good initial step would be a transparent audit of electricity sector claims which could help reduce unilateral deductions from clearance revenue transfers.

For information on the work of the IMF in the West Bank and Gaza, please see the following link: http://www.imf.org/wbg.