An International Monetary Fund (IMF) mission led by Karen Ongley visited East Jerusalem and Ramallah from July 13–25, 2016, to assess recent economic developments in the West Bank and Gaza and the financial situation of the Palestinian Authority (PA). The mission issued a press release regarding the challenges facing the Palestinian economy.

According to the press release, the Palestinian economy continues to face considerable headwinds, despite some favorable developments this year. Economic activity received a boost in the first quarter of 2016, with growth in Gaza picking up to 21 percent as donor-funded reconstruction gained momentum. For the same period, growth in the West Bank reached 4.2 percent, reflecting resilient private consumption. Still, there are far too few job opportunities and unemployment reached almost 27 percent at end‑March. Conditions are especially difficult in Gaza, where close to two‑thirds of young people are without a job, exacerbating social hardship and the already dire humanitarian situation.

Fiscal pressures eased during the first half of the year thanks to strong revenue performance. In addition to the authorities’ domestic revenue collection efforts, the ongoing dialogue between the PA and the Government of Israel boosted clearance revenue transfers. This helped to improve the fiscal balance despite pressures from unbudgeted wage increases and the unpredictable cost of domestic health referrals. The authorities minimized borrowing from banks and continued repaying old arrears to the private sector. At the same time, donor aid continued to decline and tightened the financing situation, which saw some new arrears accumulate, albeit at a slower pace than 2015.

Looking ahead, economic and political risks weigh on prospects for growth. Assuming the current security landscape continues, growth will likely reach around 3¼ percent in 2016, down from 3½ percent in 2015, and average 3½ percent over the medium term—insufficient to generate much needed jobs or meaningfully raise per capita incomes.

Efforts to develop a longer-term policy vision and promote economic cooperation are therefore vital to achieve fiscal sustainability and economic prosperity. Work is under way to finalize the PAs’ 2017–22 National Policy Agenda (NPA), which sets out policy priorities in three core areas: the path to independence, governance reform, and sustainable development. To achieve the NPA policy priorities , it will be important they are fully consistent with the 2017 budget. This can also provide a stronger basis for enhanced donor engagement.

The authorities’ ongoing actions to secure fiscal sustainability should see the recurrent fiscal deficit decline by 1.8 percentage points of GDP this year, reflecting their continued successful management of the budget in a particularly difficult environment. They are also taking steps to repay arrears to private suppliers, for which it will be important to effectively manage newly issued promissory notes. However, doing so will be difficult in the face of reduced donor aid and the resulting large financing gap of almost $500 million.

All parties have a role to play to ensure gradual and growth-friendly fiscal consolidation over the medium term. The PA should continue to promote revenue mobilization and take steps to rationalize spending while protecting the poorest. Strengthening public financial management, which is a pillar of the NPA, can facilitate more effective use of scarce finances. Reversing the decline in donor aid will be crucial to avoid too rapid budget compression and free up resources for investment. We support the PA’s efforts to further enhance revenue and improve its predictability through the ongoing dialogue with Israel.

Continued financial sector health, underpinned by strong supervision, can provide the foundation for sustained economic progress. At this juncture, the possible withdrawal of Israeli correspondent banking relationships represents a key risk to financial stability. The Palestine Monetary Authority (PMA) is proactively addressing this risk by strengthening the anti-money laundering and combating the financing of terrorism (AML/CFT) framework, in line with international standards and with support from the international community. Avoiding disruptions will preserve the functioning of the payment system and trade relations, and help prevent informal transactions that could notably dampen fiscal revenues. We welcome the Palestinian Monetary Authority’s close monitoring of banks’ health, including their exposure to the PA, and of strong credit growth for private construction and consumption.

The press release concluded with: “IMF staff is mindful that progress on the peace process and domestic reconciliation is vital to economic development. Our analysis shows that, in the absence of political uncertainty and restrictions over the past twenty years, trend growth in the West Bank and Gaza could have resulted in significantly higher real GDP per capita—around 80 percent higher than currently, under one scenario. Such a gap makes a compelling case for renewed efforts to shape a sustainable political horizon to benefit all parties. Until then, reversing the recent decline in donor budget support would help prevent a further deterioration in living conditions and free up resources for investment.”