Abstract

The historic “Declaration of Principles on Interim Self-Governing Arrangements” between the Palestine Liberation Organization (PLO) and Israel outlined the gradual future handover of responsibility to the Palestinian Authority (PA) in the West Bank and Gaza Strip (WBGS). In keeping with this declaration, the PA assumed responsibility in the Gaza Strip and Jericho area in May 1994, and for five areas of activity in the West Bank (health, education, social welfare, tourism, and direct and VAT taxation) in December 1994. The remaining areas of responsibility in the West Bank were transferred gradually to the PA following the Interim Agreement of September 1995. The economic policy framework in the WBGS was largely defined in the Economic Protocol of April 1994, which addressed economic relations between Israel and the PA (see Box 1).

The historic “Declaration of Principles on Interim Self-Governing Arrangements” between the Palestine Liberation Organization (PLO) and Israel outlined the gradual future handover of responsibility to the Palestinian Authority (PA) in the West Bank and Gaza Strip (WBGS). In keeping with this declaration, the PA assumed responsibility in the Gaza Strip and Jericho area in May 1994, and for five areas of activity in the West Bank (health, education, social welfare, tourism, and direct and VAT taxation) in December 1994. The remaining areas of responsibility in the West Bank were transferred gradually to the PA following the Interim Agreement of September 1995. The economic policy framework in the WBGS was largely defined in the Economic Protocol of April 1994, which addressed economic relations between Israel and the PA (see Box 1).

The PA has thus been confronted with the challenge of gradually assuming responsibility for most public sector functions in the WBGS. Economic management has also been complicated by frequent border closures that have disrupted the movement of goods and labor, and have thus inflicted severe damage on the economy. In these difficult circumstances, and in the absence of a domestic currency, the main macroeconomic challenge confronting the PA has been to establish a fiscal administration and ensure fiscal stability, as well as to cushion the impact of the border closures on the poorest segments of the population.

Although the economy of the WBGS is relatively free of major structural distortions, the PA will still need to take steps to create preconditions for attracting nondebt creating capital inflows and thus promoting private investment, in order to reduce the very high rate of unemployment. While security and political uncertainties are the main constraints to private sector investment currently, a transparent legal and regulatory framework will need to be established.

In keeping with the nonmember status of the WBGS in the IMF, the involvement of the IMF has been limited to the provision of technical assistance to the PA. Initially the emphasis was on assistance to establish the key economic and financial institutions, notably the Ministry of Finance and the Palestinian Monetary Authority (PMA). Since then, technical assistance has continued with the focus on improving revenue administration, expenditure management, and reforming the pension system; establishing and improving the bank supervision and check settlement systems; and creating a reliable system of macroeconomic statistics. In addition, the scope of Fund technical assistance widened in 1995–96 to include macroeconomic policy formulation. In this context, Fund staff has assisted the PA in preparing its annual budget, monitoring budgetary performance, reporting to donors, and mobilizing external financial resources.

The purpose of this paper is to review economic and institution-building developments in 1996, and to briefly assess the prospects for 1997. Chapter II provides a short overview. Subsequent chapters provide more details on fiscal (III), monetary (IV), and external (V) developments; the trade system (VI); and Fund technical assistance activity in the WBGS (VII). A review of macroeconomic statistics and of World Bank activity in the WGBS is provided in appendices. Earlier developments and the transfer of power from Israel to the PA were discussed extensively in the report entitled West Bank and Gaza Strip—Recent Economic Developments and Prospects and Progress in Institution-Building—Background Paper Issued in Connection with the 1995 Article IV Consultation with Israel, published in October 1995.

The Protocol on Economic Relations

In April 1994, the Palestine Liberation Organization and the government of Israel agreed upon a “Protocol on Economic Relations,” which had the following features:

Trade. Between Israel and the areas under the PA’s authority, trade is to be free from restrictions, with the exception of quantitative restrictions on six agricultural products (poultry, eggs, potatoes, cucumbers, tomatoes, and melons). The restrictions are to be phased out gradually according to an agreed timetable. Israeli import policies will continue to apply to trade with third countries, with the provision that the PA will be allowed some flexibility in import policies with regard to specific categories of goods, in particular goods needed for its development program and certain specified goods from Arab and other countries.

Labor. Each side will attempt to maintain normal labor movements with the other, but will retain the right to determine the extent and conditions of labor movements into its own areas of jurisdiction.

Taxation. Each side will administer its own tax policies in its areas of authority, with the main proviso that the VAT rate in the areas under the PA’s authority must not be more than 2 percentage points lower than the 17 percent currently in Israel. Taxes on international trade (including customs duties) will be shared between the two sides according to the “destination principle.” Receipts from taxes and fees paid by Palestinians working in Israel and the Israeli settlements will in large part be transferred to the PA, according to an agreed upon formula.

Money. The Palestinian Monetary Authority will be established as the PA’s official economic and financial advisor, the sole financial agent of the PA and public sector entities, the manager of the public sector’s foreign exchange and gold reserves, and the agency responsible for licensing and supervising banks and foreign exchange dealers. The New Israeli Shekel (NIS) will continue to be one of the currencies circulating in the areas of the PA’s authority, and will be accepted as means of payment for any transaction. The two sides will continue to discuss the possibility of introducing a Palestinian currency.