Palestine's economy is recovering from Covid-19 but fiscal outlook is dire, IMF says

Debt is rising unsustainably and per capita GDP is projected to fall against backdrop of persistent unemployment and poverty

A Palestinian street vendor at a market in the old city of Bethlehem in the occupied West Bank. AFP

Palestine's economy, which is largely dependent on foreign aid and grants, is recovering from the pandemic-induced recession but faces a dire fiscal outlook, the International Monetary Fund said.

The Palestinian economy began to rebound last year, growing an estimated 6 per cent in 2021 overall and 7 per cent in the occupied West Bank, as more people gained access to Covid-19 vaccines, the Washington-based lender said on Thursday.

But the economy in Gaza is estimated to have grown by just 2 per cent, partly because of the conflict between Israel and Hamas in May las year.

Despite the recovery, Palestine's gross domestic product is projected to reach its pre-pandemic level only by the end of 2023, because the economy faces a "fiscal crisis", according to the IMF.

"The Palestinian economy is recovering from the depth of the 2020 recession," said Alexander Tieman, who led an IMF staff team virtual discussion with Palestinian officials from February 17 to March 3.

"As Covid vaccines became available in late spring 2021, the Palestinian economy partially rebounded," he said.

The banking sector has recovered from the Covid-induced shock, with profitability and capital adequacy at the end of 2021 largely back to pre-pandemic levels, while deposit growth far outpaced slow credit growth, Mr Tieman said.

Palestine's economy shrank 11.3 per cent in 2020, one of its sharpest contractions on record, as its under-resourced health sector struggled to control the spread of Covid-19. The Palestinian Authority’s (PA) emergency spending cuts, which were related to halting economic and security relations with Israel between May and November 2020, also contributed to the economic contraction.

Against the backdrop of consecutive political and security shocks and despite the Ministry of Finance and Planning’s "good revenue performance", the combination of the Covid-19 pandemic, declining donor support and spending priorities have resulted in high deficits in Palestine, the IMF said.

"Under unchanged policies, the economic outlook is dire, with debt on an unsustainable path and per capita GDP projected to decline. This is against the backdrop of already persistently high unemployment and poverty, particularly in Gaza," it said.

Public debt, including arrears to suppliers and the Palestinian Pension Agency, increased to 49.3 per cent of GDP in 2021 (or 20.9 per cent excluding arrears) from 34.5 per cent of GDP in 2019.

Overcoming these fiscal challenges will require "transformational reform" with effort from the PA, the government of Israel, and the donor community, the fund said.

Palestinian authorities must develop a medium-term fiscal strategy that allows the government to invest in development projects and social spending to support Palestinians, while ensuring sustainable debt levels, it said.

The PA needs to implement spending reform — centred on the wage bill, health referrals, pensions and net lending — further broaden its tax base and undertake structural reform to improve the business environment.

"Israeli and Palestinian authorities would need to resolve fiscal leakages to boost Palestinian revenue and reduce impediments to the movement of goods and people to unleash the economy’s growth potential," the IMF said.

Boosting confidence through Palestinian-led reforms could attract donor funds, helping to ease the adjustment burden on the population and private sector companies during the economy’s transition to a more sustainable footing, it said.

A comprehensive and joint effort would strengthen macroeconomic stability and accelerate economic growth, job creation and poverty reduction, the fund said.

"The authorities’ objectives to improve the business environment, reform the wage bill and implement a new strategy to increase revenue — including, in co-operation with Israel, commencing the e-VAT project for commerce between the Israeli and Palestinian markets — are a promising start," Mr Tieman said.

However, more work is needed to turn these reform plans into concrete policy actions within a "carefully sequenced multi-year strategy" to improve the fiscal outlook and reduce debt, he said.

The 2022 budget is a "critical opportunity" to make a head start in addressing the fiscal challenges, he said.