bitterlemons.org
December 05, 2011 Edition 35 Palestinian-Israeli Crossfire
 
Ramifications of the Palestinian financial crisis
 
• Ultimately crippling  - Ghassan Khatib
We survived similar crises, but this time is different.


• Not central to independence  - Yossi Alpher
We tend to forget that when Israel declared independence it had almost no financial reserves at all.


• Already having an impact  - Mohammed Najib
Security personnel can be expected to bear this crisis for three months in a row--but not more.


• The fragility of the Palestinian economic situation  - David Brodet
This means heavy dependence--for more than two-thirds of the budget--on Israel and the donors.


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A PALESTINIAN VIEW
Ultimately crippling
 Ghassan Khatib
The Palestinian Authority has been plagued this year by various financial troubles that are affecting, in turn, its ability to fulfill some of its financial obligations. The most recent source of these problems has been a decline in PA revenues. The Palestinian budget is usually composed of two sources of income. One is external funding ($1.83 billion annually) from donors, and the other is made up of domestic revenues, direct ($812 million a year) and indirect ($1.442 billion annually collected by Israel).

In spite of the fact that the Palestinian Authority has been systematically reducing the need for external funding, that funding remains a substantial part of its budget. In the last three years, the PA has reduced a budget deficit financed by foreign aid from $1.8 billion in 2008 to $1 billion this year. Yet, some donors (for reasons that the Palestinian Authority does not know) have not fulfilled commitments made in donor conferences or in Arab League meetings. That decline in external funding began a few months before the beginning of this year and has continued to accumulate throughout 2011. It was dealt with by borrowing from banks--to the extent that the Palestinian Authority has reached the debt limit allowed by domestic laws and regulations.

In the second half of this year, a new source of financial difficulty started to emerge. Israel collects indirect taxes on commodities imported and exported by Palestinian businesses, by virtue of Israel's control over the borders. The Paris protocol, part of the Oslo agreements, stipulates that Israel should collect taxes on behalf of the Palestinian Authority and regularly transfer these revenues to it.

In June, however, Israel announced that it was not going to transfer the tax revenues for that month for reasons having to do with the political behavior of the Palestinian Authority. This added significantly to the already-existing financial troubles. The indirect taxes that Israel collects and transfers monthly are two-thirds of local revenues and almost two-thirds of the public sector wage bill. Further, Israel twice more repeated its refusal to transfer the taxes. In all three cases, the Palestinian Authority was unable to pay workers' salaries until international pressure convinced Israel to make the transfer.

This growing crisis, especially last month, created a lot of debate among Palestinians--but also among internationals involved in the peace process and the program of support to the Palestinian Authority. Their assessments indicated that the crisis created by the combination of these two factors--and especially if Israel continues withholding these tax revenues--embodies an existential threat to the Palestinian Authority. This raises the question of whether there has been an Israeli decision made to move beyond the already-existing policy of undermining the Authority to measures that might cause its collapse.

This financial crisis is not new. Nor is Israel's withholding of Palestinian tax revenues. We lived with similar crises when we had a government led by Hamas, and during Israel's 2002 reoccupation of the Palestinian territories and destruction of Palestinian infrastructure. However, the effect of the current financial crisis is different because this crisis comes on top of political stagnation. Now we have the combination of political stagnation, in which the Palestinian Authority is unable to deliver politically due to Israeli settlement activities, together with a financial crisis in which the Palestinian leadership is unable to deliver financially and economically. The combination of these is crippling.-Published 5/12/2011 © bitterlemons.org

Ghassan Khatib is coeditor of the bitterlemons family of internet publications and director of the Government Media Center. This article represents his personal views.

AN ISRAELI VIEW
Not central to independence
 Yossi Alpher
Revelations concerning the Palestinian financial crisis of recent weeks touch upon three issues. The most obvious one is the seeming inability of the Palestinian Authority under Prime Minister Salam Fayyad to accumulate sufficient reserves to withstand a few weeks' shortfall in income. Put differently, it is the PA's huge reliance on donor-nation funds and on taxes collected for it by Israel.

This is all the more striking when seen against Fayyad's repeated pledges, most recently just last week, "to make 2012 the last year . . . in which this Palestinian Authority needs any external financing to help with recurrent expenditures." To an economic novice like myself, this dissonance would appear to indicate either that Fayyad is bluffing when he claims he cannot pay PA salaries due to a single month's delay in Israeli transfer payments, or that he's bluffing when he promises fiscal independence within a year. It would be helpful to receive clarifications.

The question of Israeli transfer payments brings us to the second issue: Israel's repeated use of financial carrots and sticks--often in breach of bilateral agreements endorsed by the international community--to manipulate Palestinian political behavior. This Israeli tactic is inexcusable on three counts. For one, it violates a clear agreement with the Palestinians going back to 1994; violation of agreements is no way to build trust upon which to base future agreements. Then too, it punishes the very Palestinians, such as security forces who draw their salaries from the PA, whose allegiance to a viable two-state solution we should seek to cultivate. Finally, it relies on a bankrupt belief that manipulation of the Palestinian economy can actually moderate Palestinian political behavior.

This last aspect of the Israeli approach goes all the way back to Defense Minister Moshe Dayan's attempt to ensure a docile West Bank and Gaza Strip after the 1967 Six-Day War by encouraging Palestinians to come to work in Israel. That experiment lasted 20 years, until it literally exploded into the first intifada. But its underlying logic can be found in Prime Minister Binyamin Netanyahu's "economic peace" plan of recent years and in the failed attempt by the Olmert and Netanyahu governments to remove Hamas from power in Gaza by means of the collective economic punishment of 1.5 million Palestinians there. It is reflected yet again in the Netanyahu government's current smug satisfaction in delaying tax transfers throughout the month of November as "punishment" for the Palestine Liberation Organization's United Nations gambit.

This narrative of counterproductive economic manipulation, in turn, introduces a third issue, or rather a question: is the PA's economic state of affairs really relevant to the Palestinian quest for immediate state independence, or for that matter to a two-state solution in general? It is deceptively easy for Israeli politicians to pronounce the PA incapable of sustaining independence due to its acute financial dependence on Israel and the donor nations. We tend to forget that when Israel declared independence in May 1948, it had almost no financial reserves at all and was under siege. British mandatory authorities at the time pronounced the fledgling Jewish state "non-viable".

Still, Israel survived, flourished and absorbed millions of Jewish refugees thanks to its people's ingenuity and the generosity of world Jewry. Palestinians possess no less ingenuity. But I can't help but wonder where the Palestinians' Arab brothers are at times of acute financial pressure such as we witnessed last month. The record of the wealthy Arab countries in following through on their pledges of aid to the Palestinian Authority is abysmal. It behooves them to improve their performance, if only to take the economic issue off the agenda of those Israelis who seek excuses to delay Palestinian independence.-Published 5/12/2011 © bitterlemons.org

Yossi Alpher is coeditor of the bitterlemons.net family of internet publications. He is former director of the Jaffee Center for Strategic Studies at Tel Aviv University.

A PALESTINIAN VIEW
Already having an impact
 Mohammed Najib
The Palestinian Authority's latest financial crisis--which Palestinians widely believe was punishment for President Mahmoud Abbas' request for statehood at the United Nations in late September--has seriously impacted various sectors within the Palestinian community, including both civil sector employees and West Bank security personnel.

Israel's blockade of $200 million in taxes over two months forced the PA to borrow the amount needed to pay October salaries (stretched already by the feast holiday Eid al-Adha) for 160,000 public employees in both the security and civilian sectors. These people feed about 800,000 family members.

The PA's income depends mainly on three sources: foreign and Arab donations of about $1.6 billion a year ($130 million a month), taxes collected on the PA's behalf by Israel (another $100-120 million a month), and internal taxes at about $20-30 million monthly.

Even though this is not the first financial crisis the PA has suffered, this one is more complicated and appears to be more serious. Senior Palestinian officials and some international observers in the West Bank have gone so far as to express their deep concern that its continuation will certainly lead to the collapse of the PA.

To see how this would unfold, one most only observe that the financial crisis has already harmed Palestinian security. Fuel suppliers have warned the PA police that they will stop providing them with fuel unless they pay their more than NIS 5 million debt accrued over the past two months. This has forced the police force to reduce its patrols. Similarly, food suppliers have said they will not supply vegetables and fruit to the 8,500 policemen and 980 prisoners in PA police jails in the West Bank, unless their money is paid completely. As a result, the police force went for more than three weeks eating bread and canned meat bought previously and stored.

The inability to pay salaries will weaken the discipline of these security officers, since their commanders cannot respond to their needs, confirms the chief of a Palestinian security branch. So far, it is merely the reason behind this financial crisis--Israel's political attitude--that keeps them loyal to the security institution that protects their homeland.

These personnel can be expected to bear this crisis for three months in a row--but not more. Then they will become unable to feed their families and pay transportation to get to their work places. This has the makings of a serious threat to the PA security services and their performance of their duties.

Surprisingly, main world donors such as the United States seem to care more about the PA security agencies than the rest of the PA. A senior US official met President Mahmoud Abbas at his headquarters in Ramallah following Abbas' return from the UN, informing him that the US intends to stop paying its annual contribution to the PA budget (around $670 million), except for the $150 million dedicated to the Palestinian security services. Abbas rejected that offer and told his US guest: either you pay for all or none, and I will not accept that security is given preference over the rest of PA bodies.

While some Palestinians believe that the PA is being punished by a number of donor Arab states for the ongoing political division between factions Fateh and Hamas, other concerns were raised following Abbas' meeting with Hamas leader Khaled Meshaal in Cairo. The two leaders agreed to reactivate the reconciliation deal between the factions, and form a new national unity government excluding current PA Prime Minister Salam Fayyad. This, some fear, will force donor countries to sharply cut their finances to the PA.

Thousands of PA employees have taken out bank loans to finance the purchase of apartments, vehicles, or business projects. A halt in salaries will render them incapable of paying their monthly installments or responding to their families' needs, broadly harming businesses and the economy.

According to economists, Palestinians are classified into three groups. There are those who are directly and completely dependent on PA salaries in such a way that if the salaries stopped, they would not be able to pay their bills and loans and provide family needs. Even those who have some savings will quickly use that up. The second group provides services to the PA and its employees, including food and fuel suppliers. The third group works in the private sector and would not be harmed by a halt in the PA salaries or the ongoing PA financial crisis.

Overall, because the PA has no control over 80 percent of its income, it will continue being easily affected by those providing donations or collecting its taxes. The PA's ability to loan the money is also limited--banks are not willing to extend much more credit if the crisis extends longer than a couple of months.-Published 5/12/2011 © bitterlemons.org

Mohammed Najib is a correspondent for Jane's Defense Weekly.

AN ISRAELI VIEW
The fragility of the Palestinian economic situation
 David Brodet
The mood in the Palestinian Authority recently changed radically in the space of a few weeks. In September 2011, the attention of Palestinians and the world was directed toward the United Nations, where the Palestine Liberation Organization submitted its request to be accepted as a state by the UN and Palestinian spirits were at an all-time high.

The Palestinians announced to the world that they were ready to become a functioning, independent country. They highlighted the efforts invested by them in building professional security forces and economic and administrative institutions and in generating an economic strategy for development and growth. As proof of their capabilities, they presented positive assessments from the International Monetary Fund and the World Bank, to the effect that they were economically and institutionally prepared to take on full authority and responsibility for maintaining the economy of an independent state.

Just weeks later, the mood changed from euphoria to a hard landing in a cruel reality. The ebullient mood dropped not only because of the Security Council's rebuff of the PLO request, but also in view of a bitter daily reality that demonstrated just how fluid and fragile the Palestinian economic situation really is. The extent of the Palestinian Authority's dependence on external actors became clear to all.

Without getting into the issue of the political independence of a Palestinian state, in the economic sphere the Palestinians are very far from achieving the capacity for independent management. The heavy efforts invested in the past three or four years, mainly by Prime Minister Salam Fayyad with the support of President Mahmoud Abbas, have not yet laid the groundwork for a functioning independent country. There are both long- and short-term reasons for this.

This is the result of years of neglect and avoidance of basic economic needs on the part of the Palestinian leadership. Even after they received broad economic authority from the Paris agreement signed in accordance with the Oslo framework, the Palestinians under Yasser Arafat's leadership exploited their authority in ways that served the immediate needs of Arafat and his entourage. The large sums of aid from donor countries and tax transfers by Israel that flowed during those years were not used for building an economy.

Salam Fayyad, first as minister of finance and then as prime minister, has invested heavily in creating the infrastructure for a functioning economic authority and has registered many achievements. Yet the basic current budgetary structure of the PA, which stands at three billion dollars per annum, is dependent on donor nation transfers of around one billion dollars per annum (about a third) and on Israeli transfers of taxes collected for the Palestinians totaling around $1.3 billion (more than a third). This means heavy dependence--for more than two-thirds of the budget--on Israel and the donors.

The taxes collected by Israel on goods imported by the Palestinians are Palestinian monies that must be transferred to the PA under contractual obligation. Yet in reality, the Palestinians are dependent on an Israeli bureaucracy that on occasion invokes political considerations. For its part, the PA has failed to invest sufficient effort in building its own independent collection system, for example regarding water and electricity fees that to a large extent are never paid by consumers, thereby adding yet another financial burden.

There are undoubtedly many objective circumstances that help explain the PA's financial situation. It has no air and sea ports for direct international trade; since 2007 the Gaza-West Bank split weighs heavily on the budget; and the economic agreements signed in 1994 that were meant to last five years are still in effect today.

The PA's critical dependency on donor funds and Israeli tax transfers has become all the more salient since fiscal steps were taken to improve the Palestinian economic system. Transfer delays by Israel, for even a short period of weeks, reveal the PA's fragile economic situation. It has neither reserves nor much room for maneuver. It has no alternative source for raising funds.

Constructing a financial system is a long, drawn-out process. The PA needs to continue building itself economically, yet under current political conditions it can do little in the short term without fiscal and financial arrangements with Israel and the donors. The main damages caused by delays in transfer of funds are great uncertainty in the Palestinian economy, disruptions in the functioning of security and civilian authorities, and anger among the broad Palestinian public (mainly unemployed youth and intellectuals) that could turn violent over economic issues along the lines of the "Arab spring" demonstrations.

Israel and the donor nations share a fundamental interest in maintaining reasonable economic conditions among a population situated so close to Israel. Regardless of the question of a political solution for the conflict, Israel needs to enable Palestinians to build their economic system and it must encourage moderate and constructive sectors of the Palestinian population.-Published 5/12/2011 © bitterlemons.org

David Brodet is chairman of Bank Leumi and former director general of the Ministry of Finance. He headed the Israeli delegation to the economic negotiations with the Palestinians in Paris in 1993-4.