The World Bank / November 17, 2021
The Palestinian economy has started its recovery in 2021 as COVID-related (coronavirus) measures have been eased, but sustainable sources of growth going forward remain limited.
Given the decline in the daily number of new COVID-19 cases, lockdowns have been significantly eased in 2021. This combined with the pickup of the vaccination campaign allowed consumer confidence to slowly pick up and business activity to gradually rebound.
The economy is estimated to have grown by 5.4 percent, in real terms, in the first half (H1) of 2021, year-on-year. The improved economic performance was fully driven by the West Bank economy while Gaza’s economy remained almost stagnant in H1 2021 due to the 11-day conflict in May.
Growth is expected to further pick up throughout the remainder of the year and reach 6 percent in 2021 as the West Bank economy continues to regain more of what was lost during 2020 and with the implementation of some Israeli confidence building measures supporting economic activity and facilitating reconstruction in Gaza.
In the following years, growth is expected to hover around 3 percent as the low base effect weakens and as sources of growth remain limited given the ongoing restrictions on movement, access and trade.
Unemployment remained stubbornly high in 2021, mainly driven by Gaza. The unemployment rate in the Palestinian territories reached 26.4 percent in the second quarter of 2021: 16.9 percent in the West Bank and 44.7 percent in Gaza, reflecting the particularly difficult economic situation in the Strip due to the effect of the 11-day conflict and the ongoing restrictions.
The extremely high unemployment rate in Gaza comes hand-in-hand with deteriorating social conditions in the Strip. Estimates by the World Bank indicate that the recent conflict has pushed poverty in Gaza to 59.3 percent in 2021 (using 5.50 US Dollars a day (2011 PPP) international poverty line). This is 2.3 percentage points higher than the COVID-19 induced peak in 2020, and a 16.3 percentage point increase above the 2016-2017 values (latest available official data).
Executive Summary
- The Palestinian economy has started its recovery in 2021 as COVID-related measures have been eased, but sustainable sources of growth going forward remain limited. Given the decline in the daily number of new COVID-19 cases, lockdowns have been significantly eased in 2021. This is combined with the pickup of the vaccination campaign allowed consumer confidence to slowly pick up and business activity to gradually rebound. The economy is estimated to have grown by 5.4 percent, in real terms, in the first half (H1) of 2021, year-on-year. The improved economic performance was fully driven by the West Bank economy while Gaza’s economy remained almost stagnant in H1 2021 due to the 11-day conflict in May. Growth is expected to further pick up throughout the remainder of the year and reach 6 percent in 2021 as the West Bank economy continues to regain more of what was lost during 2020 and with the implementation of some Israeli confidence building measures supporting economic activity and facilitating reconstruction in Gaza. In the following years, growth is expected to hover around 3 percent as the low base effect weakens and as sources of growth remain limited given the ongoing restrictions on movement, access and trade.
- Unemployment remained stubbornly high in 2021, mainly driven by Gaza. The unemployment rate in the Palestinian territories reached 26.4 percent in the second quarter of 2021: 16.9 percent in the West Bank and 44.7 percent in Gaza, reflecting the particularly difficult economic situation in the Strip due to the effect of the 11-day conflict and the ongoing restrictions. The extremely high unemployment rate in Gaza comes hand-in-hand with deteriorating social conditions in the Strip. Estimates by the World Bank indicate that the recent conflict has pushed poverty in Gaza to 59.3 percent in 2021 (using US$5.50 a day (2011 PPP) international poverty line). This is 2.3 percentage points higher than the COVID-19 induced peak in 2020, and a 16.3 percentage point increase above the 2016-2017 values (latest available official data).
- In spite of significant increases in fiscal revenues, the fiscal situation remains fragile due to high public spending and very low external financing. The Palestinian Authority (PA)’s revenues grew by 18 percent in the first eight months of 2021, year-on-year, driven by an improvement in economic activity. Public spending also grew by 18 percent mainly due to an increase in the wage bill following the PA’s decision to reinstate the wages of public employees in Gaza to 100 percent in March 2021, up from 70 percent in the past several years. Assuming those trends continue for the remainder of the year and accounting for the Government of Israel (GoI)’s decision to increase its monthly revenue deductions, the PA’s deficit is expected to reach US$1.69 billion in 2021. Donor financing is projected to amount to US$184 million—38 percent of what was received in 2020. An advance payment on clearance revenues in the amount of US$153 million (NIS500 million) provided by the GoI in September 2021 has provided some relief and combined with identified aid, it is expected to reduce the financing need to US$1.36 billion. Efforts by all parties are critical to avoid a crisis as without additional financing, the PA may encounter difficulties in meeting its recurrent commitments towards the end of the year.
- To address the challenging financial situation, PA efforts alone will not be enough. Domestic bank borrowing already exceeds the limit set by the Palestine Monetary Authority (PMA), eliminating this financing option going forward. Hence, the PA may be forced to accumulate additional arrears to the private sector, pulling away more liquidity from the market. This will have a drastic impact on the economy and will eventually further reduce revenue generation. Development partners’ support is required to secure additional funds and raise budget support which is already very low and would only make a partial contribution to the gap. Support from new partners, in addition to support from the traditional donor group, is critical for closing the financing gap. Beyond the immediate priorities, the PA needs to advance the structural reform agenda. Reforms should continue to focus on improving revenues, rationalizing spending and strengthening governance, including the PFM system. PA reforms should also focus on providing a more conducive environment for the development of the private sector. In this area, the recent signature by the President of the new companies’ law and the telecoms law are critical steps in the right direction.
- Also, the GoI can play an important role through addressing some of the fiscal leakages that remain outstanding. Among other things, establishing a mechanism to electronically link the Israeli and Palestinian VAT systems and renegotiating the 3 percent handling fee charged by the GoI to handle Palestinian imports would be useful. Recent news about an understanding reached between the GoI and the PA to implement an E-VAT system in December 2021 is encouraging.
- Financial sector risks have increased due to the prolonged negative economic impact of the COVID-19 pandemic, the continued exposure to the PA’s fragile fiscal situation, and limited portfolio diversification. PA borrowing exceeded US$2 billion during 2020, reaching US$2.5 billion as of August 2021 (23 percent of total direct credit). Moreover, an indirect additional exposure to the PA are the public sector employees’ accounts, which combined represent US$4 billion, or 40 percent of total banking sector credits. The Non-Performing Loans (NPLs) ratio increased to 4.2 percent as of June 30, 2021. Overall, the NPLs concentration, and expected further deterioration in the quality of small and medium Enterprises (SME), consumer, and Gaza loan portfolios could translate into an additional increase in NPLs.
- Strong and sound prudential regulations and supervision framework is critical to ensure and safeguard the stability of the financial system. Particular attention should be given to the mutual interdependence between the fiscal imbalances and the stability of the financial sector in a context of limited policy tools that are normally available to modern economies, but not for the PA. Respect for the independence of the PMA, as supervisor and prudential regulator of the banking system in the West Bank and Gaza, is a critical pillar of a stable financial framework. In addition, ensuring the stability of cross-border payments should remain a priority policy goal for both the PMA and the PA. Due to the highly interlinked banking systems, the Palestinian economy can potentially be severely impacted by the cessation of correspondent banking relationships (CBRs). In this regard, conducting an evaluation of the existing regulatory arrangements by the Middle East and North Africa Financial Action Task Force (MENAFATF), initially planned for 2020 and postponed to the second half of 2022, should remain a short-term priority.
- The report shows that the external restrictions on Gaza resulted in a closed economy. The most recent available data shows that since 1994, Gaza’s compounded annual growth rate was only 1 percent, resulting in a dramatic decline of the contribution of Gaza’s economy to the Palestinian economy from 36 percent in 1994 to 18 percent currently. As a result, the Gaza GNI per capita is now less than a third of the West Bank’s, whereas in 1994 it represented 87 percent. Moreover, unemployment and poverty indicators have deteriorated systematically. According to UNRWA, 80 percent of the population in Gaza is dependent on international assistance. Aid and remittances are almost the only source of foreign exchange inflows that drive consumption in Gaza. Restrictions on access and movement in and out of Gaza for people and goods explain the decline in tradable activities, one of the main sources of growth for a small economy. Therefore, the physical connectivity of the Gazan economy is limited, and transport logistics activities are costly and unreliable due to the numerous controls and the deteriorated transport infrastructure.
- The structure of Gaza’s GDP has regressed toward low productivity activities and drivers of growth have all but disappeared. Gaza’s economy has undergone a deindustrialization and the economy has become highly dependent on transfers from outside, weakening its economic prospects. The productive base of the economy has been eroded with the combined size of the manufacturing and agriculture sectors falling from 27 percent of GDP in 1994 to 17 percent today. Even the services sector has reduced its share in the economy, and only the public administration has increased its share in GDP. Gaza’s investment-to-GDP ratio has declined and real capital stock in Gaza declined by 20 percent from 1994-2020. Finally, while Total Factor Productivity (TFP) has contributed to growth in the West Bank, in Gaza the TFP contribution to growth has fallen by about 0.6 percent per annum from 1997-2020.
- Tis AHLC report argues that the declining trajectory of the Gazan economy and the deterioration of the quality of life for the Gazan population can and should be reversed. To achieve this goal, first, a constructive dialogue and cooperation between the Government of Israel and the Palestinian Authority is necessary. Second, coordination between the Palestinian Authority and the international community to support the implementation of the priorities and actions identified in this report, should be ensured. Third, a short-term priority is to address the needs that were identified in the recently concluded Rapid Damages and Needs Assessment report published jointly by the European Union, the United Nations, and the World Bank.
- The report recommends focusing, on medium- and longer-term measures, to revert Gaza’s declining development trajectory. First, to restore the growth drivers, connectivity to the West Bank economy, the regional markets, and beyond, the current trade-related restrictions should be reviewed to facilitate trade, movement of people, and promote business sector. Second, basic infrastructure, in particular, continuous energy supply, high-quality water, and wastewater services, and in the modern world, a digital economy infrastructure, are needed to create an enabling environment for private sector-led growth. Third, to contribute to economic growth, and the development of the private sector and job creation, municipalities in Gaza need to be connected, offer reliable services and infrastructure, attract investment, and be responsive and resilient to shocks. Finally, ultimately, investment in human capital is critical. Today, three out of four Gazan graduates have no employment prospects. Employers, on the other hand, declare that workers lack relevant digital, language, and soft skills. As a result, in the next five years, both the skills conveyed through tertiary education and labor market opportunities for graduates need to be strengthened. While these recommendations do not tackle all the development pillars that need to be addressed to reverse the current declining development trajectory of Gaza, they are critical conditions to drive change.
- The main body of the report is organized in two chapters and one supporting annex. Chapter I focuses on recent economic developments in the real, fiscal, and banking sectors, while providing a near-term outlook that highlights critical challenges facing the Palestinian economy. Chapter II looks at Gaza’s economic performance over the past two decades. It looks at the economic and social impact of the 11-day conflict. The chapter analyses key sectors in Gaza and presents recommendations on how to address infrastructure and development needs to reverse the declining development trajectory and on how to create conditions for a sustainable path to recovery and economic and social development.
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