Ahlc report sept 2013

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The Government of Palestine’s Report to the Ad Hoc Liaison Committee

25th September, 2013 New York, USA

Ministry of Planning and Administrative Development Ramallah, P.O. Box 4557, State of Palestine Tel: +970 2 2973010 Fax: +970 2 2973012 www.mop-gov.ps

TABLE OF CONTENTS I. EXECUTIVE SUMMARY

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II. UNLOCKING STATEHOOD

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III. KEY FISCAL DEVELOPMENTS

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A. FISCAL SUSTAINABILITY AT RISK

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B. FINANCING

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C. CRITICAL REFORMS REQUIRING ISRAELI COOPERATION

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D. RESULTS OF THE PUBLIC EXPENDITURE AND FINANCIAL ACCOUNTABILITY ASSESSMENT (PEFA)

E. FISCAL REFORM PRIORITIES IV. TOWARDS A VIABLE AND PROSPEROUS STATE – UNLEASHING THE ECONOMIC POTENTIAL

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A. ECONOMIC TRENDS

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B. THE ECONOMIC INITIATIVE IN SUPPORT OF PALESTINIAN STATEHOOD

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C. “AREA C” – THE ENCHAINED GROWTH ENGINE

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D. TOWARDS A VIABLE AND PROSPEROUS ECONOMY – DOMESTIC ACHIEVEMENTS & CHALLENGES

E. ECONOMIC REFORM PRIORITIES V. PROGRESS TOWARDS ESTABLISHING THE STATE AND ITS INSTITUTIONS A. THE NEW NATIONAL PLAN – A FURTHER LEAP TOWARDS INTEGRATED PLANNING AND BUDGETING

B. DONOR SUPPORT TOWARDS PALESTINIAN STATE BUILDING

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I.

EXECUTIVE SUMMARY

The Government of Palestine, headed by Prime Minister Dr. Rami Al Hamdallah, is delighted to submit the Palestinian report to the Ad Hoc Liaison Committee and would like to seize this opportunity to reaffirm its commitment towards the state-building efforts and reforms initiated by the previous governments across a variety of sectors, including public finance management, accountability, rule of law and other core dimensions. In addition, the Government would like to express its appreciation for the generous support provided by our international partners and stress the importance of continuous dialogue and coordination in order to realize the aspiration of the Palestinian people for self-determination within a viable, sovereign and independent State of Palestine.

The Palestinian government has repeatedly reiterated its commitment to the two-state solution, based on the borders of 4th of June 1967 and international law. The prospects for realizing the two-state solution, however, have been vastly sabotaged by the continued Israeli policies of colonization, dispossession and brute force on the ground.

As a genuine partner for peace we will do our utmost to reach a breakthrough in the US-sponsored peace talks. Building on our domestic and international achievements, we will continue to invest all energy into realizing an independent and sovereign State of Palestine. Failure would have catastrophic consequences for the peoples in our region and we do hope that the Government of Israel will internalize the same sense of responsibility.

The Government is confronted with a severe financial crisis that has been mounting since 2010. This crisis is further complicated by a bleak economic outlook for the remainder of 2013 and 2014. Growth in the West Bank, which generates most of the revenues, continues to slow down. The West Bank’s real GDP shrank by 0.6% in Q1 2013. Real GDP growth in the Gaza Strip, mainly induced by donor funded projects, amounted to 12% in Q1 2013, thereby resulting in an overall real GDP growth rate of 2.7% for Palestine. This contrasts significantly with the double-digit growth figures experienced only three years ago. As a result, the Government is forced to undertake painful fiscal retrenchment policies to reduce its deficit, which in turn further negatively impact economic growth and fiscal revenues. The consequence is a downward spiral.

Within the first half of 2013 gross revenues were below budget targets, while expenditures slightly exceeded budget projections. Contributing factors to this predicament were financial flows mainly outside the direct control of the Government, such as clearance revenues and external aid, which fell short of the budgeted amounts. To maintain its liquidity and manage the sharp rise in domestic debt, the Government has to balance high levels of bank loans against the accumulation of arrears in the private sector.

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Official Development Assistance (ODA) was insufficient to bridge the deficit of NIS 572 million during the first half of 2012. External budget support declined dramatically from an average of USD 1.4 billion in 2009-10 to USD 761 million in 2011 and USD 826 million in 2012. This sharp drop since 2009 is equivalent to 12% of the GDP. Difficult fiscal reforms, however, require strong support from the international community, as well as sustained cooperation from the Israeli authorities.

The Government has initiated a number of reforms to broaden the revenue base and reduce expenditures. Those measures include the reorganization of the Ministry of Finance’s revenue department, enhancing the operations of the Large Taxpayer’s Unit, reviewing generous tax exemptions for new enterprises under the Investment Promotion Law, phasing out on petroleum subsidies, and pushing the Government of Israel to share full information on revenue transfers with the aim of avoiding tax evasion. On the expenditure side we have made great progress in reigning in the wage bill.

Based on limitations imposed on hiring and salary increases in the public sector the wage bill has declined from 26% of GDP in 2006 to 16% in 2013. The full implementation of the Procurement Law in Q1 2014 will result in further substantial savings.

In spring 2013 the Government of Palestine (GoP) cooperated with the World Bank, the European Union, France and the UNDP in conducting a Public Expenditure and Financial Accountability (PEFA) assessment. The assessment credited institutional reforms within the Ministry of Finance and confirmed noticeable improvements to the public financial management (PFM) system, particularly in the field of transparency, comprehensive budgeting, control and audit, as well as aspects of accounting and reporting. The PEFA confirms that, “despite a challenging political and institutional context in recent years, PFM reform has been high on the agenda of the PA. Significant work has been done towards implementing international good practices, and there is broad agreement between the PA and the international development community to continue to pursue these efforts.” Concurrently, the “prospect of continued fiscal stress affecting the PFM reform agenda is still high.”

Despite the vigorous reform efforts exercised by the Government, fiscal stability is unattainable without an end to the Israeli occupation and its prohibitive restrictions.

After decades of Israeli imposed de-development, the Palestinian economy experienced donor-induced growth more recently, which was important to offset some of the consequences of Israeli restrictions on access and movement. However, as the International Financial Institutions have repeatedly pointed out, donor-induced growth is unsustainable in the long term and falls short of unleashing economic development under conditions of belligerent occupation.

With ODA flows dwindling, the Palestinian economy reverses into an economic slowdown, triggering rising unemployment and poverty. Unemployment in Palestine, according to ILO standards, stood at 20.6% in the second quarter of 2013 (com-

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pared to 20.9% in Q2 of the previous year). To contextualize this figure it is important to know that unemployment on average drops by some 3% in Q2, compared to Q1 and Q3. Compared to Q2 2011, unemployment in the Gaza Strip increased by 2.3% while in the West Bank unemployment rose by 1.4% over the past two years. Youth unemployment among the age group of 15-24 reaches 29.1% in the West Bank and 54.2% in the Gaza Strip.

Unleashing the potential for economic development, particularly in “Area C,” by granting Palestinians full access to their lands and natural resources would result in a cumulative GDP growth of 40%, based on conservative estimates.

The resources generated by such domestically-driven economic development would exceed ODA levels by far and would form a strong pillar for a robust and viable State of Palestine, in which its citizens can live in peace and prosperity.

Within the tight corset imposed on us by the Israeli occupation we need to progressively improve Palestinian economic performance and expand on opportunities. Our strategic economic objectives are as follows: • Diversify the Palestinian economy; • Develop an enabling business and investment environment; • Enable and empower Palestinian institutions to facilitate economic development and regulate markets.

In translating these objectives into tangible action we have achieved steady progress over the past years. The Government drafted a “National Export Strategy of the State of Palestine,” based on selected priority sectors(1) and geared towards lowering unemployment and reducing the trade deficit. Palestine has been successful in concluding a number of bi – and multilateral free trade agreements with diverse partners such as the European Union, the European Free Trade Association, the Greater Arab Free Trade Area, Mercosur, Jordan, Egypt, Saudi Arabia, Canada, Russia, the United States and Turkey. In December 2012 a Draft Debt Resolution Law was finalized, which once enacted will address issues around resolving insolvency. Regulations on establishing private limited liability companies were revised in order to support entrepreneurs in starting a business. The burden of minimum capital requirements for these companies has been reduced significantly. Efforts are currently underway to reduce procedures, time and costs required for obtaining construction permits and for registering property. Recently, databases on credit scoring and bounced checks have been developed that assist banks and microfinance institutions in assessing credit ratings for companies and individuals. The databases are geared towards easing access to credit. Further, laws pertaining to land ownership, such as the Land Law and the Land Registration Law, will be prioritized despite Israeli imposed limitations on access 1 Selected priority sectors include products such as stone and marble, olive oil, agro-food, textile and garments, footwear and leather, furniture and priority services that encompass tourism and ICT.

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to land registration records. A new Company Law is expected to unify legislation across Palestine and speed-up the process of establishing a business. In addition, a Secured Transaction Law will facilitate the utilization of movable assets for collateral purposes and thus expedite access to credit schemes. Functioning markets also require proper regulation. For this purpose we intend to enact an existing draft law on establishing an independent regulatory body mandated to maintain competitive markets.

The Economic Initiative, developed by the Office of the Quartet Representative and initiated by the United States Secretary of State, John Kerry, is a strategic initiative aims to substantially decrease unemployment and promote longer-term sustained economic growth in Palestine, by promoting the development of eight target economic sectors over the course of three years. The Economic Initiative draws on plans developed by the Government of Palestine and reflects many of our national development priorities. The Economic Initiative’s successful implementation therefore is a strategic interest of the Palestinian government. This will however require the strong commitment of and coordination between different parties: the private sector, the international community, the Government of Palestine and the Government of Israel.

Palestinians are eager to trade with the world, to market quality products abroad and to welcome tourists from all corners of the globe, but we cannot do it alone, especially under the restrictions imposed by the occupation. The potential for a sustainable Palestinian economy is inextricably linked to a political settlement and the realization of the two-state solution.

The Government is in the process of drafting a national development plan for 2014-16, that will succeed the Palestinian National Development Plan (PNDP) 2011-13. The new development plan for 2014-16 will further integrate planning with budgeting, as part of the transition towards program-based budgeting. Once again the national development plan for 2014-16 will be underpinned by 23 sector strategies. Sectoral programs will become the basis for budget execution. The plan and the budget will be guided by a sound medium-term fiscal framework covering three years.

We expect the approval of the National Development Plan for 2014-16, alongside the budget for 2014, by the end of December 2013.

Over the past year the Palestinian government has consistently called upon donors to pursue a more integrated approach across the political and development realm, particularly in those areas of Palestine currently categorized as “Area C.” The response of our international partners has been encouraging and suggests that donors have recognized the importance of engaging in so-called “Area C” as a means of preserving the option of a viable State of Palestine. Within this report we present an example of best-practice engagement in “Area C.” To provide further guidance for engagement in “Area C” and East Jerusalem, the Government intends to issue a separate strategy paper before the end of the year. This “Area C/East Jerusalem” strategy paper will complement the National Development Plan for 2014-16.

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II.

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The Palestinian government has repeatedly reiterated its commitment to the two-state solution, based on the borders of 4th of June 1967 and international law.(2) Our state-building drive, with the support of the international community, has been geared towards realizing our national aspirations by firmly establishing the institutional foundations for the State of Palestine. As a result, we have crossed a number of successful milestones in our state-building endeavor, and the AHLC has applauded our institutional reforms while the UN General Assembly has, with overwhelming majority, recognized Palestine as a non-member observer state.

Notwithstanding our domestic and international achievements, the prospects for realizing the two-state solution on the ground have been vastly sabotaged by continued Israeli occupation, land confiscation, home demolition, settlement expansion, settler violence, price tag attacks on our holy places, and policies geared towards stealing Palestinian natural resources and evicting Palestinians from their lands.

Keeping in mind our strategic vision and the rapidly closing window for implementing a comprehensive agreement on the basis of the two-state solution, we have agreed to the resumption of US-sponsored direct negotiations with the Government of Israel, with full commitment and determination to overcome the remaining obstacles in our quest for freedom and peace. It is our firm belief that a just two-state solution will lead to peace and prosperity in our region.

Previous Israeli “offers” fell short of the minimum requirements necessary for the establishment of a viable, sovereign and independent State of Palestine, as well as for the full and unequivocal implementation of International Law. More recently, a number of statements made by leading Israeli politicians within the governing coalition, and from within the governing Likud party, have not given Palestinians any reason for enthusiasm, particularly statements denying the Palestinian people any right to selfdetermination or independence.

Despite international and national protests, Israeli settlement construction has continued to increase rapidly. New settlement activity almost tripled in 2013, reaching a 7-year high,(3)

2 Particularly the Fourth Geneva Convention and the International Criminal Court Rome Statute regarding the transfer of civilian populations into occupied territory, UN Security Council Resolutions 242, 338, 478, 1397, 1515 and 9 July 2004 ICJ Advisory Opinion on the Separation Barrier.

3 Ian Deitch, “Settlement starts nearly triple in 2013,” The Times of Israel, 9 June 2013, http://www.timesofisrael.com/settlement-housing-starts-nearly-triple-in-2013/.

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with most of the new construction taking place deep inside the West Bank.(4) According to figures released by the Israeli Central Bureau of Statistics, new construction in the West Bank, outside of East Jerusalem, jumped from 313 settlement units in Q1 2012 to 865 in Q1 2013.

Further, one week after Palestinians and IsSystematically Sabotaging the Negotiaraelis resumed direct tions negotiations under the (Update as per 11 September 2013) auspices of US Secretary of State John Kerry, • 7 August 2013: Israeli Civil Administration approves the Israeli Civil Adminisconstruction plans for 878 settlers apartments in the West Bank; tration(5) approved construction plans for an • 11 August 2013: Israeli Minister of Housing grants fiadditional 878 housing nal approval for 1,187 settler apartments in the West Bank and East Jerusalem; units across a number of settlements in Pales• 12 August 2013: Israeli Housing Ministry confirms tine.(6) Only days later that additional permits for the construction of some 900 settler apartments in East Jerusalem were isthe Israeli Minister of sued.

Housing granted final approval for the construction of an additional 1,187 apartments for settlers across East Jerusalem and the remainder of the West Bank;(7) when completed these housing units will add another 9,705 illegal settlers(8) to the conflict equation.

4 “Construction Starts in Settlements Reach 7 Year High,” Americans for Peace Now, 10 June, http://peacenow.org/entries/construction_starts_in_settlements_reach_7_year_high#.UjBWkovmQcA. 5 The Israeli Civil Administration, a military body governing civil affairs in the occupied West Bank, should have been dissolved pursuant to the Declaration of Principles.

6 Chaim Levinson, “Despite renewal of peace talks, Israel approves plans for hundreds of residential units in West Bank settlements,” Haaretz, 8 August 2013, http://www.haaretz.com/news/diplomacy-defense/.premium-1.540481.

7 Middle East News, 11 August 2013 – I couldn’t find this exact source so I’ve listed a different news outlet that matches the reference: Karin Laub and Mohammed Daradhmeh, “Israeli Settlements Get GoAhead on Eve of Palestinian Peace Talks,” The Huffington Post, 11 August 2013, http://www.huffingtonpost. com/2013/08/11/israel-settlements-palestine-talks_n_3739508.html.

8 According to data published by the Israeli Central Bureau of Statistics, in early February 2013 the average family size in “Judea and Samaria,” which, in Israeli terminology, is synonymous for the West Bank excl. East Jerusalem, stands at 4.7 persons.

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New Israeli Settlements Units in the West Bank

Construction Begun

Q2-2013

Q2-2012

Q1-2013

Q1-2012

Q2-2013

Q2-2012

Q1-2013

1,000 900 800 700 600 500 400 300 200 100 0 Q1-2012

Number of Israeli Settlements

The number of new settlement units built in the f irst half of 2013 almost equals the units built during the entire previous year

Construction Completed

Graph Adapted by Author, source: Israeli Central Bureau of Statistics

Through steady illegal settlement expansion the number of Israeli settlers in Palestine has climbed from 260,000(9) in 1993, the year when the Declaration of Principles was signed, to some 567,000(10) as of mid-2013; in the West Bank alone (excluding East Jerusalem) the population of Israeli settlers has more than tripled since the signing of the Declaration of Principles 20 years ago.

9 Publications, “By Hook and by Crook – Israeli Settlement Policy in the West Bank,” B’Tselem, July 2010, http://www.btselem.org/publications/summaries/201007_by_hook_and_by_crook.

Note: the B’Tselem report includes separate figures for the West Bank and East Jerusalem, which were added together. In addition some 4,000 settlers residing in Gaza at the time were added to the B’Tselem figures.

10 According to the Israeli Central Bureau of Statistics as of mid-2013 some 367,000 Israelis resided in “Judea and Samaria,” i.e. the West Bank excluding East Jerusalem. According to OCHA’s East Jerusalem Fact Sheet from December 2012 some 200,000 Israeli settlers reside in Palestinian East-Jerusalem. The figure is based on Israeli Central Bureau of Statistics figures of 2011. One can safely assume that the number has increased considerably since 2011, given the spur in settlement construction.

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600,000

Israeli Settlers in the West Bank and East Jerusalem 2001-2012

Population

500,000 400,000 300,000 200,000 100,000

Israeli Settlers

0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Graph Adapted by Author, source: 2001-2011 data via B’Tselem; 2012 data via PCBS. Data includes East Jerusalem.

While settlements are being built at a speedy pace, 324 Palestinian structures(11) were demolished in the West Bank (including East Jerusalem) during the first six months of 2013,(12) mainly around settlements and areas designated as firing zones.(13) Following a period of calm during the month of Ramadan demolitions resumed at full speed shortly thereafter. Around mid-August another 40 structures were demolished within just two days.(14) As a result, 653 Palestinians became homeless since the beginning of 2013, adding to the steady flow of thousands of previously displaced Palestinians from lands categorized as “Area C.” The systematic measures of demolitions and displacements are another indication that the Israeli government is not serious about the peace process and continues to pursue a policy by which Israeli demographic presence is expanded, while Palestinians are being uprooted.

Starting in July 2011, Palestinian communities in “Area C” have submitted 42 master plans to the Israeli Civil Administration. As of September 2013 not a single master plan has received approval. Meanwhile, the Israeli Civil Administration is drawing up its own master plans for some Palestinian communities in “Area C”. The later plans are being prepared without any involvement or consultation with the affected communities and 11 The term “structure” includes residential buildings, makeshift Bedouin housing, as well as different types of farming and commercial buildings, schools, etc.; data on the number of demolitions by the type of structure is not available. However, each structure demolished affects the livelihoods of Palestinian families.

12 UNOCHA, “Humanitarian Bulletin – Monthly Report,” June 2013.

13 Firing zones in the West Bank equal the areas designated as “Area A.” 14 UNOCHA, “Update on demolitions and displacement,” 20 August 2013.

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their implementation will lead to further Palestinian displacement.

In addition to systematic displacement and dispossession the exercise of physical violence by Israeli occupation forces against Palestinian citizens reached a new peak in the first half of 2013, when 2,640 Palestinian citizens were injured – the highest number of injuries since the Second Intifada.(15) Among those injured are many children.

The unchecked and excessive force applied against Palestinian civilians briefly made international headlines in mid-July when Israeli soldiers were caught on camera arresting 5-year old Wadi’a Maswadeh from Hebron, an act later justified by the IDF legal adviser as legitimate in order to “thwart the threat posed by the activities of a minor.”(16) Meanwhile, Palestinians in the Gaza Strip have endured more than 6 years of de-development under an Israeli-imposed regime of collective punishment. Living conditions in the Gaza Strip have steadily deteriorated since 1999 and the siege imposed in 2006 has all but halted essential development activities for the 1.8 million inhabitants.

As a result of years of siege the regular supply of tap water has become an exception rather than the norm. Furthermore, by now some 90% of water extracted in the Gaza Strip is not safe for human consumption. Electricity outages last for up to 12 hours a day.(17) Further, unemployment stands at a staggering 31.5%(18) while 57% of households are food insecure.(19) Simply put, the situation in Gaza is untenable from every possible angle. The status quo in the Gaza Strip will most likely continue to perpetrate hopelessness and the escalation of violence for as long as a just two-state solution remains unrealized.

Palestinians in East Jerusalem remain confronted with Israeli policies aimed at evicting them from their homes and their city. In past reports we have reported about house demolitions in East Jerusalem, the rapid settlement expansion in the Palestinian capital, the segregation of Palestinian neighborhoods by the construction of the Separation Wall, the discriminatory municipal zoning that prevents Palestinians from obtaining construction permits, and the inequitable provision of services to Palestinians in East Jerusalem. A problem that affects every single Palestinian family in East Jerusalem is the systematic discrimination in relation to the education system. The Government of Israel and the Jerusalem municipality invest little in Palestinian education infrastructure in East Jerusalem, blatantly ignoring the Fourth Geneva Convention and a 2011

15 UNOCHA, “Humanitarian Bulletin – Monthly Report,” June 2013.

16 Gili Cohen, “IDF Legal Advisor: Detention of 5-year-old Palestinian boy was legitimate,” Haaretz, 31 July 2013, http://www.haaretz.com/news/diplomacy-defense/.premium-1.538995.

17 UNOCHA, “The Gaza Strip: The Humanitarian Impact of Movement Restrictions on People and Goods”, July 2013, http://www.ochaopt.org/documents/ocha_opt_gaza_blockade_factsheet_july_2013_english.pdf.

18 PCBS, Q2 2013 labor data.

19 UNOCHA, “The Gaza Strip.”

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Israeli Supreme Court ruling.(20) As a result of the chronic shortage of classrooms only some 46% of students are able to study in official municipal schools.(21) The remaining students need either to attend expensive private schooling or schools in the West Bank, with the latter option putting them at risk of their Jerusalem residency status being revoked by Israel. Moreover, thousands of Palestinian children have to undergo the excruciating experience of crossing a checkpoint every morning on their way to school, ever since the Separation Wall cut off East Jerusalem neighborhoods from each other.

Accordingly the drop-out rate among 12th graders in East Jerusalem is 40%.(22) Those who pass high school matriculation exams find it difficult to gain acceptance into Israeli universities, as degrees from Palestinian universities are not recognized in Israel.(23) Negatively affecting the quality of education, the education sector in East Jerusalem suffers from the absence of a Palestinian steering body and an inability to recruit teachers, since Palestinians with a West Bank ID are prevented from teaching in East Jerusalem. Furthermore, the Israeli authorities are entrenching the occupation of East Jerusalem through the education system by imposing an Israeli curriculum on Palestinian students, thereby negating their Palestinian national identity.

The Government of Palestine would also like to re-emphasize that our strategic choice of a two-state solution is shared by our neighbors and regional partners, who have equally committed themselves to the formula of land-for-peace within the Arab Peace Initiative. We will continue to exercise all efforts, as a genuine partner for peace, to end the occupation and realize an independent and sovereign State of Palestine. We hope that the Government of Israel will internalize the same sense of responsibility.

20 In February 2011 the Israeli Supreme Court ordered the Government of Israel to create, within five years, a physical infrastructure to absorb all Palestinian students who wish to enroll in municipal schools. If, after five years, any student remains without a place in the municipal school system, the Israeli government will have to cover the tuition required by “recognized but unofficial” schools.

21 The Association for Civil Rights in Israel, “East Jerusalem – By the Numbers,” May 2013, http://www.acri. org.il/en/2013/05/07/ej-figures/.

22 ibid 23 ibid

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III.

KEY FISCAL DEVELOPMENTS

A. FISCAL SUSTAINABILITY AT RISK The Government of Palestine (GoP) is confronted with a severe financial crisis that has been mounting since 2010. The crisis is further complicated by a bleak economic outlook for 2013 and 2014, with steadily declining growth rates.

Economic growth in the West Bank, which generates most of the revenues, is slowing down. For the first time, during the last decade, there was a contraction in the West Bank economy of 0.6% in Q1 2013. Due to the sharp decline in external assistance from USD 1.4 billion in 2009-10 to about USD 800 million in 2011-12, the Government is forced to undertake fiscal retrenchment policies to reduce its deficit. These in turn further reduces economic growth and fiscal revenues, especially given that much of the current growth is driven by the fiscal deficit. The result is a downward spiral. To maintain its liquidity and manage the sharp rise in total public debt, amounting to 38% of GDP(24) by mid-2013 (compared to 26% in 2010), the Government has to balance between high levels of bank loans and the accumulation of arrears with the private sector. Excessive arrears towards the private sector, however, work to further undermine Palestinian private sector growth and the provision of services to the Government. At the same time, the Government cannot borrow endlessly from the small, albeit healthy, domestic banking sector. Given the multi-layered Israeli economic restrictions, coupled with the accumulation of Government arrears towards the private sector, economic growth is expected to decline even further.

Within the first seven months of 2013 gross revenues exceeded those of the previous year but remained well below their budget target, while expenditures slightly exceeded budget projections. This outcome mainly was due to financial flows outside the direct control of the Government, such as clearance revenues and Official Development Assistance (ODA), which fell short of the budgeted amounts. The Government’s fiscal operations up until July 2013 are summarized below in more detail: Gross revenues in the first seven months of 2013 amounted to NIS 5.16 billion, a 4% increase over the same period last year. Gross revenues were below the budget target

by NIS 479 million, or 9%, due to shortfalls in clearance revenues, ODA, domestic tax and nontax revenues. When projected for the full year, gross revenues are expected to reach NIS 8.94 billion, which is a 6% increase over gross revenues in 2012.

Total expenditure and net lending reached NIS 7.82 billion during January – July 2013; an increase of 4% over the first seven months of 2012. Expenditures were above the budget target by NIS 179 million, equal to 2%, mainly due to net lending exceeding 24 Total public debt includes all pension arrears and private sector arrears;

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its budget target. When projected for the full year, total expenditure and net lending is estimated to reach NIS 13.5 billion, an increase by 3% over the spending level in 2012.

The total budget deficit before external aid for the first seven months of 2013 amounted to NIS 3.67 billion, which is above the budget target by NIS 646 million, or 21%, and results in an increase of 14% over the same period last year. The total end-of-year deficit is projected to reach NIS 6.4 billion, an increase of 5% over the 2012 deficit.

The recurrent budget deficit amounted to NIS 3.14 billion, which is above the budget target by NIS 872 million, or 38%, and reflects an increase of 14% over the recurrent deficit of the first seven months of 2012. It is estimated that the recurrent end-of-year deficit will reach NIS 5.4 billion in 2013, which equals an increase over last year’s recurrent deficit by 4%.

Domestic debt stocks reached NIS 4.79 billion, as the treasury reduced its domestic debt at commercial banks by NIS 353 million during the first seven months of 2013.

The Palestinian Government's Public Debt 2000-2011 2500

Million USD

2000

1500

1000

500

0 2000

2001

2002

Total Public Debt

2003

2004

2005

2006

Total Foreign Debt

2007

2008

2009

2010

2011

Total Domestic Debt

Graph Adapted by Author, Source: Palestinian Monetary Authority.

Total net accumulation of arrears for the first seven months of 2013 reached NIS 1.15 billion, including development expenditures arrears of NIS 156 million. Arrears to the private sector reached NIS 597Â million.

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Figure 1: Budget Performance Actual Jan-July 2013

Actual Jan-July 2012

% Change

Projection for Full Year 2013

Projection 2013 over actual 2012

NIS mill.

NIS mill.

%

NIS mill.

%

Gross Revenues

5156.9

4962.1

4%

8943

6%

Total Net Revenue

4677.9

4744.0

-1%

8112

2%

Total Expenditure and Net lending

7815.9

7493.2

4%

13472

3%

Current Balance

-3138.1

-2749.2

14%

-5360

4%

529.6

466.6

13%

1014

8%

-3667.6

-3215.8

14%

-6374

5%

Budget Classification

Development Expenditure Balance

Attaining progress in fiscal reform under current circumstances raises immense challenges and requires strong support from the international community, as well as sustained cooperation from the Israeli authorities. On the revenue side we are facing two structural problems: first, our tax system is highly skewed towards indirect taxes which account for 91% of total tax revenues, while the income tax only accounts for 9% of revenues. This makes our tax system quite regressive and limits our ability to raise indirect taxes further. This problem is closely related to the second structural problem, namely low compliance with both income tax and indirect taxation: as for income tax, only 20% of taxpayers are currently shouldering the entire tax base while 80% of potential contributors are hardly paying anything. To broaden the tax base and reduce the fiscal deficit several measures have been initiated: • The MoF revenue department has been reorganized along functional lines. We have appointed a Director for the Large Taxpayer’s Unit and we are providing incentives for MoF Tax Officers to improve compliance.

• Our Investment Promotion Law has been generous to the extent that it has affected our tax base. While it may be difficult to reduce the incentives already provided under the law, we are now establishing strict criteria for any new enterprise which will seek to benefit from this law.

• With respect to clearance revenue evasion by Palestinian traders, joint Palestinian/Israeli technical committees have met to establish a data transfer for customs and VAT aimed at reducing leakages. Progress in these areas will be critical in improving our revenue performance.

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• By gradually moving towards market prices for petroleum products, we are reducing the revenue loss incurred on petroleum excises, with the objective of eliminating this “tax refund” by the end of 2013.

On the expenditure side, we are currently unable to reduce significantly the size of the civil service and the security forces given the repression of the economy by Israeli restrictions and the resulting high unemployment rate. Similar political constraints have prevented us from reducing the heavy expenditure burden we have been incurring in the Gaza Strip. Nevertheless, we have been taking several measures to rationalize expenditures in areas which we can control: • We have made great progress in reigning in the wage bill, our largest spending item (52% of total recurrent expenditures), by limiting both new recruitment and salary increases. As a result, the wage bill has declined from 26% of GDP in 2006 to 16% in 2013. For the 2014 budget we intend to maintain the policy of freezing net-hiring and curtailing salary increases.

• With respect to the Procurement Law, implementing regulations have been drafted and a procurement committee has been appointed so the law can be implemented in Q1 2014. With the establishment of a central public procurement agency, procurement processes will become more transparent and effective. We expect substantial savings as a result.

• We are also reviewing Ministry of Health expenditures, particularly the large expenses associated with hospital referral of patients to Israel and other neighboring countries.

• Net lending, in specific electricity and water payments on behalf of municipalities(25) are costing the central government NIS 70 million per month. This is unsustainable. To tackle the problem we require detailed information from the Israeli authorities on the deduction of electricity expenses from our clearance revenues, so that we can hold delinquent municipalities and individuals accountable. We will vigorously pursue the reorganization of our electricity bill collection mechanism through regional distribution companies and the establishment of a national umbrella transmission company so as to reduce the net lending burden on our budget.

• We will be re-launching our pension reform on much firmer ground after having had extensive consultation with the public employee unions, as well as other members of the civil society and the World Bank.

Despite these efforts by the Government, further integrated efforts are necessary to attain fiscal stability. Cooperation from Israel and other donors is essential for these future reforms to bear fruit.

25 Utility arrears accumulated by municipalities to Israeli electricity providers are being deducted from revenue transfers to the Palestinian Ministry of Finance (without proper information from the Israeli side).

De-facto, this results in the unintentional subsidization of utility payments through the national treasury.

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B. FINANCING External budget support declined dramatically from an average of USD 1.4 billion in 2009-10 to USD 761 million in 2011 and USD 826 million in 2012. This sharp drop since 2009 is equivalent to 12% of the GDP (a decline from 20% of the GDP in 2009, down to 8% in 2011 and 2012 respectively). For several years we have been meeting at the AHLC twice a year and the donor community applauded our reform agenda.

While in some cases we were not able to fully implement all reforms within the envisaged time frame, it is important to stress that most of these reforms have involved painful measures which directly impact real wages and benefits. Such measures can only be implemented if our budget is fully funded and if salaries are paid on time.

In addition to the shortfall in budget support, disbursement of external assistance has been erratic. This has resulted in salary payment delays, weakened public confidence in the Government, and an upset in our cash management system. The volatility in disbursements and the shortfall in external assistance have put the Government under acute financial stress.

We initially attempted to cover this financing gap by borrowing from commercial banks reaching a prudential limit of indebtedness of USD 1.3 billion in both 2012 and 2013.

When the Government’s bank debt is combined with the debt incurred by government employees, domestic banks’ exposure to the Palestinian government would amount to 40% of bank credit provided to the economy. Clearly, this sovereign risk cannot be expanded further. Moreover, most of this debt is short term, with high interest rates, fees and charges.

However, this bank borrowing fell short of covering the recurrent financing gap, forcing the Government to incur additional credit through payment arrears to the private sector. These arrears reached a peak of USD 600 million in 2012 and since, the Palestinian government managed to reduce them to about USD 400 million. Nevertheless, these payment arrears to the private sector have withdrawn a huge amount of liquidity and have had a corrosive effect on economic activity, undermining confidence in governance and slowing private sector investment. Therefore, we will do our utmost to fully repay private sector arrears and put in place a mechanism which will avoid the accumulation of new arrears.

To address these two problems, namely the high level of short term bank debt and private sector arrears, our intention is to restructure our bank loans by lowering our interest charges, stretching out our debt repayments, and issuing treasury bonds in consultation with the banks. Such restructuring will improve the maturity structure of our debt, reduce the cost of our borrowing and strengthen the capital adequacy ratio of the lending banks. If the initial subscription by banks to Government bonds proves successful, we may raise additional capital to retire private sector arrears. Considering that our public debt, including arrears to the private sector and to the Pension Fund does not exceed 37% of the GDP, there is room to raise our public debt while keeping it well within the Maastricht prudential limit on public debt (60% of GDP).

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C. CRITICAL REFORMS REQUIRING ISRAELI COOPERATION Critical reforms towards balancing the budget within 24 months would be greatly facilitated if the Israeli authorities were to support Palestinian measures by improving the economic environment and confidence-building measures. There are a number of quick fixes which can be undertaken and which would greatly enhance our economic growth prospects and fiscal revenues. A proactive policy by the Israeli authorities should take place on several fronts: • Facilitation of movement and access within the West Bank and between the West Bank, the Gaza Strip, and East Jerusalem. Exports from Gaza are the lifeline of our economy and Israel needs to allow the resumption of domestic trade between the West Bank, including East Jerusalem, and the Gaza Strip, as well as exports abroad in line with UN Security Council Resolution 1860. Especially now, as the tunnels from Egypt to the Gaza Strip have mostly been demolished, the resumption of trade with the West Bank (incl. East Jerusalem), Israel and Egypt can be done in line with the Agreement on Movement and Access from 15 November 2005. This would enhance Government revenues substantially(26) and improve growth prospects for Gaza, the West Bank and East Jerusalem.

• Israel can assist the Government in facilitating in-kind donations of petroleum products from friendly countries by allowing the buildup of the necessary infrastructure to channel petroleum products to the Palestinian market.

• We would require Israeli cooperation on halting leakages in revenue transfers.

For example, there are substantial custom duties on indirect imports through Israel not remitted to the Palestinian government. Estimates for losses related to this tax revenue range between USD 70 million to USD 100 million per year.

• According to the Paris Protocol the Palestinian government is expected to receive half of the border crossing exit tax (originally USD 25) collected by Israel on behalf of the Palestinian government. However, after the tax was raised to USD 42, the Palestinian side continues to receive half of the original tax. Israel would need to raise transfers to the Palestinian side to half of the current tax rate.

Our fiscal strategy is undergoing a paradigm shift with the objective of attaining a primary balance in our recurrent budget over a period of 18-24 months. This stabilization strategy, which will be fully articulated this upcoming November, will accelerate reforms aimed at reducing the fiscal deficit both over the short and medium term. A more balanced budget would allow us to shift external aid from recurrent expenditures to development projects, thereby enhancing growth prospects. Achieving the objective of attaining fiscal sustainability will raise immense challenges and we will need strong support from the international community, as well as sustained cooperation from the Israeli authorities to realize our goals.

26 Prior to the Israeli siege the Gaza Strip used to contribute 28% to the Government’s revenues. Today, it is only contributing 14%.

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D. RESULTS OF THE PUBLIC EXPENDITURE AND FINANCIAL ACCOUNTABILITY ASSESSMENT (PEFA) Public finance management (PFM) entails the ability to execute the groundwork for political decisions and translate policies into financial allocations. Public finance management is thus essential for the effective delivery of public services and good governance.

In spring 2013 the Government of Palestine has cooperated with the World Bank, UNDP, the European Union and France in conducting a Public Expenditure and Financial Accountability (PEFA) assessment to identify strengths and challenges for the public finance management system. The assessment credited institutional reforms within the Ministry of Finance and confirmed noticeable improvements of the PFM system compared to 2007, particularly in the fields of transparency, comprehensiveness of the budget, control and audit, as well as aspects of accounting and reporting. In the assessment of the PEFA report progress is “particularly impressive” considering that the PFM system was almost rebuilt from scratch under challenging conditions, following the relocation of institutions from Gaza Strip to the West Bank in mid 2007.

The assessment was also helpful in identifying challenges. Three key challenges were identified by the PEFA: • The late involvement of the cabinet in the budget preparation process, which weakens the ability of the policy making level to steer financial allocations in accordance with national policy priorities; • The accumulation of arrears incurred by line ministries is not properly reflected in budget reports and affects overall budget performance; • The imprecise budgeting of external donor assistance, particularly for budget support.

The PEFA report acknowledges that two out of these three challenges have already been addressed by the Ministry of Finance; the recent set-up of a Macro Fiscal Unit at the Ministry of Finance will help improve overall budget preparation and introduce a more policy-driven approach to budgeting. Secondly, in preparation for the 2013 budget, the process for forecasting budget support from donor partners took into account all available information, including information gathered by donors. As such, forecasted budget support in 2013 fully reflects actual expected budget support, thereby improving the overall reliability of the budget and its predictions.

Furthermore, in July 2013, the Ministry of Finance started to implement a new system for the management of public expenditure. Coupled with technical assistance by our development partners, the new system will help curtail arrear accumulation and improve reporting of arrears within the financial system.

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The PEFA confirms that, “despite a challenging political and institutional context in recent years, PFM reform has been high on the agenda of the PA. Significant work has been done towards implementing international good practices, and there is broad agreement between the PA and the international development community to continue to pursue these efforts”. Concurrently, the “prospect of continued fiscal stress affecting the PFM reform agenda is still high.”

E. FISCAL REFORM PRIORITIES Given the volatility of external financing, a key objective of the Government is to reduce external dependency, while increasing the space for targeted economic and social policies. For this purpose the Government of Palestine needs to broaden its revenue basis and further cut on expenditures as much as possible.

As outlined previously by the Government and the International Financial Institutions, the major constraint in broadening revenues is Israeli imposed restrictions on access and movement, as well as Israeli policies that obstruct the Palestinian economy throughout Palestine. This limits our enforcement authority and substantially reduces tax compliance.

Given the occupation induced constraints, the Palestinian public finance management system is required to perform at its optimum and make the most out of the currently available assets. Harnessing domestic resources more efficiently requires a basic number of reforms, to which we are fully committed: 1. Reform of the Taxation System: Currently about 20% of taxpayers carry some 80% of the tax burden. The overall income tax revenue to GDP ratio remains relatively low, partially as a result of generous tax waivers under the Investment Promotion Law. To boost revenue collection, the Government agreed on a multi-annual plan in February. As part of this plan the Government will merge all existing tax departments under a single organizational umbrella to streamline operations.

Implementation of the plan commenced with the merger of the value added tax (VAT) and the customs department.

However, further measures are required in the short-term. Our taxation system especially needs to cover all profitable businesses in Palestine. The Ministry of Finance’s Large Taxpayer Unit (a relative term given the small-scale structure of businesses) estimates that there is a considerable number of business entities which would fall under its mandate, but are not yet registered. Efforts are thus underway to reach out to businesses and distribute the tax burden more equitably.

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Currently, the Government also reviews generous tax exemptions for new companies under the Investment Promotion Law, a step that requires careful balancing between fiscal needs and investment promotion. A revised draft law is expected by the end of September.

Full implementation and enforcement of a self-assessment scheme for taxation is also high on the agenda of the Government; such a system will decrease tax administration requirements and enhance tax revenues.

2. Reform of the Pension System The pension system is financed by recurrent expenditures instead of accrued reserves. As a result it accumulates huge arrears and faces the risk of collapse in the future. Progress in the implementation of the pension reform plan that we launched in mid-2010 needs to be evaluated. We need to redouble our energies in areas where we have fallen behind and reinvigorate the pension reform plan in order to place our pension system on more solid ground.

To broaden coverage of the pension system and support entrepreneurs, the Government is currently working on setting up a pension fund that will also cover the private sector.

3. Information Transparency on Revenue Transfers The Government is committed to implementing the timetable and agenda for improving cooperation and information exchange on clearance revenues with the Government of Israel, as outlined in the exchange of letters from 31 July 2012 and in the bilateral meeting with the Israeli Minister of Finance on 16 June 2013.

Beginning in September 2013 a data interface has been installed between Israeli and Palestinian customs officials, whereby Israel transfers to the Palestinians all customs declarations on direct imports on a post clearance basis within 24 hours. This is a major step forward, but the transfer is not affected in real time thereby substantially reducing Palestinian custom officials’ enforcement capability.

4. Reform of Wage Expenditures The limits on hiring and salary increases implemented over the past years have yielded strong results. In 2006 public sector wages accounted for 26% of the GDP. This figure dropped to 16% in 2013. We are committed to further reducing the public wage bill, but we need to carefully consider political realities under low economic growth and high unemployment; especially as further downsizing of the public sector could have unintended consequences if it is not accompanied by private-sector led growth and recruitment.

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5. Reform of the Health System Expenditures in the health system have risen drastically over the past decade and need to be curtailed in order to allow for sustainability; especially the referral of patients to hospitals abroad. This process requires more robust control mechanisms on the whole, which includes a standardized and equitable referral process, competitive procurement of referral services, and the revision of referral benefits. In the absence of reforms the referral system as a whole will become untenable.

6. Targeting Social Assistance Programs The National Cash Transfer Program (NCTP) is a model for successful reform.

Yet, in order to enable the Government to provide durable assistance to families in extreme poverty the system requires further refinement and adaptation.

We are hence committed to improve targeting of services toward extremepoverty cases and toward developing differentiated mechanisms for assisting other social hardship categories.

7. Infrastructure for Imports of Petroleum Products from Neighboring Countries If Palestinians were allowed to build up the necessary infrastructure to channel petroleum products from friendly countries to the Palestinian market, the treasury would benefit from in-kind donations of petroleum products.

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IV.

TOWARDS A VIABLE AND PROSPEROUS STATE: UNLEASHING THE ECONOMIC POTENTIAL

A. ECONOMIC TRENDS While there is commitment across the Government to broaden the revenue basis and to exercise robust efforts toward fiscal reform, the overall economic trends are not supportive. The West Bank’s real GDP shrank by 0.6% in Q1 2013 as a result of a very weak private investment under Israeli restrictions. Real GDP growth in the Gaza Strip, mainly induced by donor funded projects, amounted to 12% in Q1 2013. Growth in Gaza is also expected to decelerate further as the crack down on tunnel activities continues, which provide most of the material for construction and manufacturing in the coastal strip. The overall real GDP growth rate for Palestine in Q1 2013 stands at a meager 2.7%. This contrasts significantly with the double digit growth figures experienced only three years ago. In accordance with the International Financial Institutions we also expect that medium-term prospects for growth are bleak, unless the political context improves significantly.

Without an end to the Israeli occupation, in particular the siege on the Gaza Strip and Israeli restrictions on “Area C” and East Jerusalem, private-sector driven sustainable economic growth is unattainable, resulting in increased unemployment and poverty.

Unemployment in Palestine, according to ILO standards, stood at 20.6% in the second quarter of 2013 (compared to 20.9% in Q2 of the previous year). Adding those who became frustrated by the labor market, actual unemployment reached 24.5% in Q2 2013.

To contextualize this figure it is important to know that on average unemployment drops by some 3% in Q2, compared to Q1 and Q3. This strong variation in unemployment is mainly triggered by seasonal factors, such as labor intensive periods in agriculture and in construction. Regional discrepancies remain wide, with unemployment in the Gaza Strip reaching 31.5% in Q2 2013 (taking into account labor force participants who gave up on seeking employment), thereby cementing its depressing record of having one of the highest unemployment rates in the world. Compared to Q2 2011, unemployment in the Gaza Strip increased by 2.3%, while in the West Bank unemployment rose by 1.4% over the past two years.

Living in a society that is unable to provide prospects is a natural incubator for political instability. With unemployment rates among the age group of 15-24 reaching 29.1% in the West Bank and 54.2% in the Gaza Strip the potential for wide-spread disillusionment with the political and social status-quo is growing. The current economic reality condemns the vast majority of a generation to wake up each morning without any prospects, and deprives society at large of one of its most precious potentials.

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The potential for a sustainable Palestinian economy is inextricably linked to a political settlement and the realization of the two-state solution. For this reason the achievement of sovereignty by far will be the single biggest boost for the Palestinian economy.

In the past, Palestine experienced economic growth that was delinked from development and even amounted to de-development. Palestinian-induced economic development has been curtailed and made to fit Israeli sub-contracting requirements as a result of the occupation, while Palestinian labor was largely re-oriented towards the needs of the Israeli labor market. The value chain of the Palestinian economy was disrupted by the occupation; from the confiscation of resources (mostly land and water), to restrictions on means of production (high-end machinery, fertilizers, etc.), down to access to local and international markets. The forced economic integration into Israel has, in the early days, resulted in short term growth on the one side, but structural dedevelopment on the other. The forced integration process deliberately undermined the establishment of a sustainable economic basis for Palestinian statehood. The result is a geographically fragmented private sector that is dominated by micro and small enterprises with heavily restricted access to local and international markets, and that is subjected to repeated disruption and political uncertainty. The majority of the remaining Palestinian companies are hence unable to embark on meaningful investments that would increase their competitiveness beyond the isolated local market, let alone in the international markets.

Additionally, given the Israeli-imposed limitations, particNo Service for Palestinians ularly restrictions on imports under the “Dual Use” list, agOne of the many arbitrary obstacles, by which the ricultural and industrial proGovernment of Israel attempts to translate the ocduction remain weak, therecupation into currency, is the telecommunication by curtailing the export sector. For years the Government of Israel has potential of the Palestinian refused to grant Palestinian companies the nececonomy. With the establishessary 3G frequencies to enable modern mobilement of the Palestinian Naphone communication, citing, as usual, “security” tional Authority, however, loconcerns. In reality Palestinian customers are becal entrepreneurs, coupled ing pushed towards subscribing to Israeli mobilewith an influx of Diaspora exphone companies for the very same services that perience and know-how, are being denied to Palestinian mobile-phone were remarkably successful companies. for alleged “security” concerns. in establishing a service sector, which today dominates the Palestinian economic structure. Though even the service sector remains restricted by the Israeli occupation regime (see box “No Service for Palestinians”).

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More recently, the Palestinian economy experienced donor-induced growth, which was important to offset the consequences of Israeli restrictions on access and movement. However, as the International Financial Institutions have repeatedly pointed out, donor-induced growth is unsustainable in the long term and falls short of unleashing economic development under conditions of belligerent occupation. In the absence of Israeli easements on access and movement, economic growth is directly linked to ODA flows. Consequently, the brief period of real per-capita growth that characterized recent years was mostly donor-induced and currently reverses into an economic slowdown as ODA flows dwindle. This in turn triggers (once again) a decline in real per-capita growth, as well as rising unemployment rates.

A viable and sovereign State of Palestine requires growth based on sustainable economic development. Today’s trade balance is entirely negative and impossible to finance with current domestic resources. According to the Palestinian Bureau of Statistics, exports in May 2013 totaled around USD 71.8 million, while imports reached USD 396.2 million during the same month.(27) Overall, the share of exports of goods in relation to the Palestinian economy stood at a meager 7% in 2012 (down from some 10% in 1996) and is thus among the lowest export ratios in the world. Although, compared to 2012, the growth in exports has significantly outpaced the growth in imports the gap between both figures is too large to be bridged for as long as the occupation continues.

Export, Imports, Trade Balance in Palestine 2000-2012 8000 6000

Million USD

4000 2000 0 -2000 -4000

Trade Balance

Import

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

-6000

Export

Graph Adapted by Author, source: Palestinian Central Bureau of Statistics, 2013

27 Palestinian Central Bureau of Statistics, “Palestinian Registered External Trade in Goods,” May 2013

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Sustainable economic development requires structural changes in the capacity of the Palestinian economy to invest, produce, refine, and eventually export goods and services. Our first and foremost priority to spur economic development is to obtain our rights to access domestic resources, most importantly, land. Without the realization of our sovereign rights, economic growth and prosperity will remain an illusion. However, while re-instating our rights is a necessary and moral obligation of the international community, it is not sufficient to reverse decades of Israeli imposed de-development overnight.

Realizing the full potential of the Palestinian economy requires continued international assistance. Towards this end, investment initiatives, particularly those aimed at spurring private sector growth and in “Area C,” are crucial to our development efforts and are in line with our development priorities. At the same time, international support for economic development needs to go hand-in-hand with political support and real progress towards the realization of a sovereign State of Palestine based on the borders of 4th of June 1967, with East Jerusalem as its capital. Short-term economic benefits are not a substitute for political progress towards freedom and independence. Ultimately only political sovereignty will enable us to establish a truly viable economy and reduce our dependency on external funding.

B. THE ECONOMIC INITIATIVE IN SUPPORT OF PALESTINIAN STATEHOOD The 3-year Economic Initiative, advanced by the United States Secretary of State and the Office of the Quartet Representative, aims at creating transformative growth in the Palestinian economy and advance the Government’s national development objectives and priorities. The Initiative pays special attention to substantially reducing unemployment in Palestine by promoting investments in private initiatives, developing public infrastructure and promoting institutional reforms needed to achieve sustained economic growth.

The Initiative targets the development of eight strategic economic sectors: construction, building materials, Information and Communication Technology (ICT), tourism, light manufacturing, agriculture, water and energy.

The Economic Initiative’s successful implementation is a strategic interest of the Palestinian Government. To that end, the development of Palestine’s 2014-2016 National Development Plan will take into account the plans set-out in the Economic Initiative, promoting tighter alignment between the efforts of the international community in the Economic Initiative and those of the Government of Palestine over the coming 3-year period.

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The implementation of the Economic Initiative will require the strong commitment and active engagement of and coordination between different parties: the private sector, the international community, the Government of Palestine and the Government of Israel. To enable the sector development, a number of critical measures are required, including: • Ease of movement of people and goods throughout the West Bank and Gaza Strip and between Palestine and states, including Israel; • The development of public infrastructure necessary to attract and develop businesses in Palestine, including in transportation, energy, water and telecommunications; • Institutional and legislative reforms by the Government of Palestine needed to promote sustained, equitable growth; • Removal of barriers to development in Area C, Gaza and East Jerusalem

C. “AREA C” – THE ENCHAINED GROWTH ENGINE In our March 2013 report to the AHLC we outlined the following priority sectors that carry with them the potential for real long-term sustainable economic development(28):

Agriculture The agriculture sector has the potential to add some 20-25% to the GDP and simultaneously absorb large quantities of unskilled labor if Palestinians were able to develop their own land and water resources, especially in “Area C.” Such potential is currently being curtailed by Israeli-imposed restrictions on access to lands and water, especially in the fertile Jordan valley and other parts of “Area C” where illegal settlement construction and expansion are being promoted while the Palestinian economy is being starved. Thus, instead of fulfilling its promising potential, the agriculture sector is being marginalized within the current political reality and is only contributing a meager 6% to the Palestinian GDP.

28 In late 2012 the Palestinian government commissioned a study to analyze the economic potential of the Palestinian economy with a particular focus on blocked resources of so called “Area C,” with a particular emphasis on agriculture, natural resources, and tourism. This section of the report is mainly based on that study.

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Palestinian Agriculture Performance shows slight improvement since 2002 1000 900 800 Million USD

700 600 500 400 300 200 100 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012* Agriculture Output Value

Agriculture Value Added

Graph Adapted by Author, source: PCBS, 2012 (*2012 data is preliminary).

Quality year-round vegetables are among the most profitable agricultural products.

While less than 8% of agricultural lands are cultivated with vegetables, they account for about 44% of agricultural revenues. According to the study recently commissioned by the Palestinian government, the Jordan Valley would be suited to produce highvalue vegetables, flowers and herbs at the value of USD 1 billion per year (such production patterns would also require access to fertilizers, which is heavily restricted by Israel). Demand for quality agricultural products is high among the Gulf Cooperation Council as well as European markets. Yet today, as a result of Israeli policies geared toward the development of illegal settlement products at the expense of Palestinian products, the Jordan valley has the lowest number of Palestinian agricultural holdings in all of the West Bank, proportionally.

Total Value of Registered Palestinian Exports, Imports and Net Trade Balance of Agricultural Goods in Palestine, 2011 150 116.97

50

24.39

-94.30

Israel

18.18

6.21

Other Countries

22.67

-100

Net Trade Balance

Imports

Israel

Israel

-50

Other Countries

0 Other Countries

Million USD

100

Exports

-150

Graph Adapted by Author, source: PCBS, 2012.

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Natural Resources Natural resources, also mainly located in lands currently designated as “Area C,” constitute another potential source of prosperity and economic development. Natural resources encompass energy resources (including off-shore gas fields), Dead Sea minerals and quarries and mines. Under current Israeli access restrictions these resources are largely off-limits for Palestinian investors and are exploited by Israel and Israeli settlements in contravention to international law. Combined, these natural resources could add a further 15-17% to the Palestinian GDP.

Gaza’s Offshore Gas Fields Gaza’s “Marine” gas fields are located fully within Palestinian territorial waters, around 30km offshore, and hold an estimated 1 trillion cubic feet of natural gas with a value of some USD 4-6 billion. The development area contains another field, named the “Border Field” that holds ca. 0.1 trillion cubic feet of gas. The “Border Field” straddles the Palestinian-Israeli maritime boundaries, and borders the “Noa South” field on the Israeli side.

The development of the Gaza “Marine” fields has been stalled since the discovery of the gas reserves in the late 1990s, due to Israel’s unwillingness to grant the project’s developers, BG Group and CCC, approvals and clearances required to access the area.

The US Company Noble Energy holds the development rights to the “Noa South” gas field, and is now considering developing the reserves. Unilateral development of “Noa South” will, however, also deplete the reserves on the Palestinian side.

It is worth noting that development of Gaza “Marine” will have a transformational effect on the Palestinian economy, with an estimated USD 2 billion in direct revenue to the Palestinian treasury, and over USD 8 billion in energy cost savings over 15 years, if the reserves are used for domestic power generation.

Tourism The tourism industry presents a tremendous potential for growth of the Palestinian economy. Its unique historical and topographic features, including the Dead Sea, constitute an untapped resource. Moreover, common cultural, historical, and natural backgrounds characterize the tourism networks in the region, and most tour programs are composed of two or more countries in which Palestine could take part. Being at the crossroads of a number of regional touristic tracks, Palestine is a significant attraction

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for both international and regional tourists. According to a JICA 2006 study,(29) tourism for Palestine is not limited to religious pilgrims, but is rather composed of five different types including cultural, nature, resort, and agro tourism.

Gross Value Added of Tourism Enterprises, 2011 90

Million USD

80 70 60 50 40 30 20 10 0 Travel agency activities

Short term accommodations

Restaurants

Long-distance bus services

Car Rentals

Visitor assistance for Haj & Umra

Retail sale of souvenirs

Wooden souvenirs manufacturing

Graph Adapted by Author, source: PCBS, 2013.

However, the lack of adequate infrastructure, limited activities, lack of access to important sites and limited business opportunities all present a challenge to a Palestinian tourist sector. For example, while 4.79 million tourists visited the West Bank in 2012, only 1.03 million overnight stays were recorded (see graph below). The average tourist to Palestine stays only 2.3 nights, with very little seasonal fluctuation.(30) Occupancy concentrates mainly on Jerusalem and Bethlehem, which jointly account for around 80% of all stays. The remainder is mainly distributed between Ramallah and Jericho.(31) Despite the significance of Palestine’s religious sites and their close proximity, visitors from Arab countries only accounted for 2.1% of hotel occupancy in 2012.(32) The above trends are a direct result of Israeli restrictions on access and movement that obstruct the development of Palestinian-owned infrastructure at the country’s most valuable tourist locations, including the Dead Sea shore located in “Area C.” According to a recently commissioned study the development of Dead Sea tourism alone could boost the Palestinian GDP by another 5-6%.

29 “Jericho Regional Development Study,“ JICA, 2006.

30 PCBS, “Hotel Activities in the Palestinian Territory,” 2012.

31 PCBS, “Hotel Activities in the Palestinian Territory,” Second Quarter 2011.

32 PCBS, “Hotel Activities in the Palestinian Territory,” 2012.

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Tourism Trends in Palestine: 2008-2012 Local and International Tourism

6.00 5.00

4.945

4.832

0.829

0.886

4.790

Millions

4.00 3.00 2.00 1.00

2.594 2.116 0.578

0.610

1.030

0.00 2008

2009

No. of Tourists in Palestine

2010

2011

2012

No. of Overnight Stays in Palestine

Graph Adapted by Author, source: Ministry of Tourism and Antiquities, 2013.Data excludes East Jerusalem.

In addition, development within the above mentioned sectors would lead to positive spillover effects and induce the development of other economic sectors, particularly the service sector and industry. Developing the agriculture sector, for example, would require large investments in storage and transportation logistics, as well as marketing and financial services.

Unleashing the above mentioned potential for economic development by granting Palestinians access to their lands and natural resources would result in a cumulative GDP growth of up to 40%, based on conservative estimates. The resources generated by such domestically-driven economic development would exceed ODA levels by far (combined humanitarian, development and budget support) and would form a strong pillar for a robust and viable State of Palestine, in which its citizens can live in peace and prosperity.

We continue to urge our international partners to provide financial support, but even more importantly we require political backing for our vision of establishing a sustainable economic foundation on which the State of Palestine will thrive. We need to unlock statehood and realize sovereignty and independence in order to realize Palestine’s promising economic potential.

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D. TOWARDS A VIABLE AND PROSPEROUS ECONOMY – DOMESTIC ACHIEVEMENTS & CHALLENGES With strong progress in institution-building, our national development process has had positive implications on the Palestinian economy and the business environment. Reestablished security and rule of law in the areas controlled by the Palestinian government have reinforced economic growth and private sector confidence. Building on the progress achieved in institution building, we need to refocus our energies on private sector driven economic development as a pillar for statehood and support the private sector to fully develop its potential.

Pursuing sustainable economic development in light of the entrenched, belligerent Israeli occupation, however, is unrealistic, as we have outlined above. Access and movement to local and international markets remains heavily restricted, and our natural resources are being controlled and exploited by the Israeli government and its illegal settlement enterprise. Because our opportunities and resources are so limited we need to utilize what is available to maximize efficiency and lay the foundations for viable economic development across the whole of the State of Palestine.

Due to the devastating effects of Israeli occupation we need to progressively improve our performance and expand our opportunities. Our vision is to establish a free, competitive and fully sovereign economy that is part of the international trade network. If our economy may be unleashed and allowed to achieve its full potential it will contribute to social cohesion and prosperity. With this in mind, and based on the Economic Development Sector Strategy, our strategic economic objectives are as follows: 1. To diversify the Palestinian economy by expanding our trading partners’ list for both goods and services, and by restructuring the basis of our productive sector.

2. To develop an enabling business and investment environment on the basis of a competitive regulatory framework, and a sound infrastructure that is capable of facilitating local, regional, and international investments.

3. To enable and empower Palestinian institutions to facilitate economic development and regulate markets.

Progress and challenges related to these strategic economic objectives is sketched out below.

First strategic economic objective: diversify the Palestinian economy The Palestinian economy needs to diversify in order to develop. Existing trade agreements with Israel are being implemented in a one-sided manner and, for all practical purposes, currently restrict and undermine Palestinian economic ability to develop and export high-value products to the Israeli market or abroad.

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The Palestinian Government has drafted a “National Export Strategy of the State of Palestine,” based on selected priority sectors(33) and geared towards lowering unemployment and reducing the trade deficit. Implementation of the strategy is expected to directly increase export competitiveness of Palestinian enterprises as well as to improve the business environment for expanding exports.

Over the past years the Government of Palestine has been successful in concluding a number of bi – and multilateral free trade agreements with diverse partners such as the European Union, the European Free Trade Association, the Greater Arab Free Trade Area, Mercosur, Jordan, Egypt, Saudi Arabia, Canada, Russia, the United States and Turkey. Palestine is also a member of the Agadir Agreement, targeting export of products to the EU market. We regard these free trade agreements as an important step towards expanding and diversifying our external trade patterns, especially once Israeli imposed access and movement restrictions on Palestinian goods are lifted. Currently, the preferential market access provided by free-trade agreements remains largely unutilized as a result of Israeli impediments on movement of goods, discrimination against Palestinian products at Israeli ports, complicated rules of origin in FTA’s and a lack of recognition of Palestinian certificates of origin amongst other obstacles. In addition, we have also observed a capacity gap among Palestinian producers to fully make use of existing free trade agreements.

While the aim is to reduce dependency on the Israeli economy, the Israeli market will continue to be of importance for the Palestinian economy, and we are open to discuss economic cooperation projects as long as they are beneficial to Palestinian economic and political interests.

Progress in restructuring production patterns has admittedly been slow. Towards this objective we need to come forward with an integrated strategy for MSMEs (which make up for the vast majority of our enterprises) that will enable those enterprises to have access to technology, research & development, credit schemes, and markets.

A strategy for MSMEs also needs to take into account management and IT skills as well as the provision of market intelligence and other business support services. Our productive sector continues to be dominated by micro and small industries, with very limited investment opportunities. Currently 97% of Palestinian enterprises employ less than 9 persons. The small-scale structure of Palestinian enterprises is a result of decades of de-development imposed by the Israeli occupation, which actively prevented the formation of a competitive Palestinian industry. Under current circumstances of protracted crisis, small, family-run enterprises also have some advantages: profound knowledge of the local market, proven resilience in the face of crisis and under economic pressure they are less likely to lay-off workforce. Yet, within a globalized econ33 Selected priority sectors encompass products such as stone and marble, olive oil, agro-food, textile and garments, footwear and leather, furniture selected priority services encompass tourism and ICT.

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omy these enterprises will remain confined to the isolated local market if they are not allowed to develop, invest and modernize. Over the upcoming national planning period we will hence need to devote considerable efforts towards supporting micro, small and medium enterprises (MSMEs) in order to modernize, to increase productivity, and to reach beyond the local markets.

Furthermore, we must place considerable emphasis on rehabilitating the industry in the Gaza Strip, where entrepreneur skills have laid barren for more than a decade as a result of physical destruction and the siege imposed by Israel.

The transformation of our productive structure needs to go hand-in-hand with increasing Palestinian labor force capacity. This process starts already with school education, where the Government is modernizing the curricula and teachers’ training with the aim of encouraging critical reflection and the acquisition of cognitive skills. Further cornerstones in our approach are Technical and Vocational Education and Training (TVET) as well as continued on-the-job education and training. Exposure to international business establishments is proven to have a massive impact on the acquisition of technical and managerial skills. However, this exposure is most difficult for Palestinians for two pivotal reasons. First, foreign direct investments in Palestine are limited due to an unfavorable political situation; second, Israeli travel and residency restrictions make it difficult for Palestinians to gather sufficient in-depth experience in working with companies abroad, this applies specifically to Palestinians residing in the Gaza Strip and in East Jerusalem.

Second strategic economic objective: develop an enabling business and investment environment There is no doubt about the need to improve the Palestinian business and investment climate. The current Palestinian legal framework is fragmented. It includes Ottoman, British, Jordanian, and Egyptian legislation as well as Israeli military orders and more recently Palestinian legislation. Different sets of laws apply to different geographic areas, such as the West Bank, the Gaza Strip and East Jerusalem. In the 2013 World Bank Doing Business (WBDB) Report, Palestine ranked 135 out of 185 economies.

While some categories assessed in the report, such as trading across borders, are largely out of the Government’s control, other aspects of the business climate, such as business start-up, insolvency, and access to credit can be addressed by domestic Palestinian legislation.

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World Bank Ease of Doing Business Ranking for Middle East and North Africa Easiest

Saudi Arabia United Arab Emirates Qatar Bahrain Oman Tunisia Kuwait Morocco Malta Jordan Egypt, Arab Rep. Lebanon Yemen, Rep. Palestine Syrian Arab Republic Iran, Islamic Rep. Algeria Iraq Djibouti

Hardest

0

50

100

RANKING

150

200

Graph Adapted by Author, source: World Bank Doing Business Report, 2013.

The Government has mandated a technical team to address all aspects of improving the business environment in Palestine. This team is led by the Ministry of National Economy (MoNE) and includes the Palestine Monetary Authority (PMA), the Palestinian Bar Association, the Palestinian Investment Promotion Agency (PIPA), the Ramallah Chamber of Commerce representing the Federation of Palestinian Chambers of Commerce and the Palestinian Federation of Industries.

Some of the main results that have so far emanated from the technical team are listed below: • In December 2012 a Draft Debt Resolution Law was finalized, which once enacted will address issues around resolving insolvency.

• The team has been revising regulations on establishing private limited liability companies in order to support entrepreneurs in starting a business. The burden on minimum capital requirements for these companies has been reduced significantly.

• Efforts are currently underway to reduce procedures, time and costs required for obtaining construction permits and for registering property. A reform of Land Authority procedures is critical for registering property.

• Recently, databases on credit scoring and bounced checks have been developed to assist banks and microfinance institutions in assessing credit ratings for companies and individuals. The databases are geared towards easing access to credit.

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In addition to the measures described above the Government has invested considerable efforts to establish a competitive regulatory framework covering other dimensions of the business environment: • Recognizing the importance of land ownership for business transactions, the Government has formed a Land Policy Task Force and endorsed its recommendations. As a result, the Land Authority Law was promulgated in 2010. Further laws pertaining to land ownership, such as the Land Law and the Land Registration Law, will be prioritized, despite Israeli imposed limitations on access to land registration records.

• A new Company Law is expected to unify legislation across Palestine and speedup the process of establishing a business.

• In addition, a Secured Transaction Law will facilitate the utilization of movable assets for collateral purposes and thus expedite access to credit schemes.

• Functioning markets also require proper regulation. For this purpose we intend to enact an existing draft law on establishing an independent regulatory body mandated to maintain competitive markets.

The legislative priorities above are not exhaustive but are rather meant to indicate where our focus will lie. Beyond this primary legislation there is also a need to review secondary legislation which might be incomplete or require updating. Such secondary legislation includes regulations for the Palestinian capital market, for commercial agents, for banking, for industrial zones, as well as for income taxation.

Protecting Investors Index Djibouti Iran, Islamic Rep. Yemen, Rep. Iraq Jordan United Arab Emirates Syrian Arab Republic Lebanon Morocco Oman Qatar Algeria Egypt, Arab Rep. Bahrain Malta Palestine Tunisia Kuwait Saudi Arabia

*Higher Index Value indicates more protection

0

5

10

15

INDEX

Graph Adapted by Author, source: The World Bank Doing Business Report, 2013.

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By establishing industrial zones we aim to provide required infrastructure for stimulating investment. Yet, under current circumstances, our industrial zones remain isolated, and thus they are inadequately linked to other domestic and international markets. Remaining major economic infrastructure bottlenecks are international gateways such as an airport, a seaport and trans-border highways across entry and exit points to be controlled by Palestinians, particularly Allenby Bridge and Rafah. In addition, Palestine lacks a modern road network that connects all of its territory. Without sovereignty over its territory and its borders, the Government of Palestine remains unable to establish such crucial infrastructure and thus unable to unlock the economic potential of the Palestinian economy.

Within the context of economic infrastructure, reliable energy supply at competitive prices is essential for economic development, especially in the productive sectors. Reliable power supply is a major constraint in the Gaza Strip, which faces long hours of outages on a daily basis as a result of physical destruction by targeted Israeli bombardment of civilian infrastructure. An expansion of the industry in Palestine will hence require extensive investments in the power sector. Accordingly, the diversification of energy sources, including the promotion of solar energy, is a key strategic objective of the Palestinian energy sector strategy. To establish a modern regulatory framework for the energy sector the Government intends to issue a new Energy Law.

Third strategic economic objective: enable and empower Palestinian institutions to facilitate economic development and regulate markets Our aim is to extend the project of institution building to governmental and non-governmental bodies that help to encourage overall private sector performance for the benefit of Palestinian society. Such institutions include the Ministry of National Economy, a private sector coordination council, the Chambers of Commerce, research institutions, and other relevant bodies. In this context the re-opening of the Jerusalem Chamber of Commerce constitutes an important component for the revitalization of Palestinian economic development in the capital. As such, the Chamber of Commerce is the enabling and representative body for private sector driven development in East Jerusalem.

Starting in 2011, the Palestinian government has introduced new modalities for all public procurement to encourage a competitive market economy. The core of this procurement reform is the Procurement Law enacted in 2011, which sets out the legal framework for launching an independent High Council of Procurement to monitor all public procurement processes. This year by-laws have been issued to make the Council operational.

Palestinians are eager to trade with the world, to market quality products abroad, and to welcome tourists from all corners of the globe, but we cannot succeed in our goals under occupation. In order to realize our potential we need support from our international partners.

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E. ECONOMIC REFORM PRIORITIES This section outlines top economic priorities for the Government and urges the international community to support the Government in implementing the priorities financially, politically, and through technical assistance. Details on the below priorities can be obtained from the Ministry of Planning and Administrative Development (MoPAD) and the Ministry of National Economy (MoNE).

1. The Quartet’s Economic Initiative The implementation of the Economic Initiative in Support of Palestinian Statehood, advanced by US Secretary of State John Kerry and the Middle East Quartet, is a strategic priority for the Palestinian government.

The Economic Initiative aims to develop eight key sectors over a period of 3 years through strategic initiatives that have the potential to transform the overall Palestinian economy. Investments under the plan would be made in construction, agriculture, tourism, light manufacturing, energy and water, ICT, as well as in the public and social sector. The Economic Initiative aims to spur private sector investment and has the potential to significantly accelerate economic growth.

The plan’s successful implementation requires that certain legislative and institutional reforms be implemented by the Government of Palestine and that critical public infrastructure be developed throughout the West Bank and Gaza Strip.

Crucially, the plan’s implementation requires that barriers to the movement of people, vehicles and goods throughout the West Bank and Gaza Strip be removed, that cheap and efficient trade between Palestine and the rest of the world be facilitated, and that the blockade to the development of “Area C,” including East Jerusalem, be lifted.

2. Opening of Gaza Crossings The opening of all crossing points in the Gaza Strip at their full potential and in both directions is of pivotal importance for the Palestinian economy. A re-opening of crossing points needs to include the Karni/Al-Montar cargo crossing, which, as a result of massive financial investments in the past, is the best equipped cargo crossing into the Gaza Strip and thus has the highest cargo capacity.

United Nations Security Council Resolution 1860 from 8 January 2009 calls upon Member States “to ensure the sustained reopening of the crossing points on the basis of the 2005 Agreement on Movement and Access between the Palestinian Authority and Israel.”

The significance of reopening the Gaza crossing points goes beyond the Gaza Strip, since import and export revenues from the Gaza Strip constituted a vital source of government revenues. To harness the full economic and fiscal potential of the coastal strip’s economy requires the political reunification and the implementation of the Cairo and the Doha agreements on reconciliation and the re-

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opening of the Rafah crossing point for people and goods in line with the 2005 Agreement on Movement and Access.

3. Access to International Markets Access to international markets is a vital component of a private-sector led growth strategy.

Our priority is to facilitate the construction of international gateways such as the Palestine International Airport in Al Buqei’a, West Bank, and the Gaza Sea Port.

Additionally, we need to enhance trade between Palestine and our regional neighbors. Currently trade is obstructed by extremely limited border facilities coupled with highly cumbersome procedures that serve to quash any comparative advantage of Palestinian products.

4. Economic Legislation With the aim of unifying economic legislation and easing business procedures we are committed to revising primary and secondary legislation. Prioritized legislative reform includes the Land Law and the Land Registration Law, a new Company Law, a Secured Transaction Law, a Competition Law, a Financial Leasing Law and a Debt Resolution Law. 5. Promotion of Business Support Services Business promotion requires the provision of business support services in order to allow businesses to acquire information and skills that might be difficult to obtain on the market at a reasonable cost. Such services include information on local, regional and international markets (market intelligence), support in the implementation of standards, facilitation of contacts, provision of management and IT competencies and other services.

It is the Government’s policy to empower private-sector bodies, such as Chambers of Commerce, Trade, and Industry, as well as governmental bodies, such as the Ministry of National Economy, to acquire the necessary capacities.

6. Introduction of 3G Telecommunication Frequencies The Palestinian telecommunication sector can boost economic growth only when it is not obstructed from introducing modern 3G technology required for smart phones. Israel needs to release technical equipment held up in Israeli ports for over a year and provide 3G frequencies to Palestinian companies.

7. Termination of “Dual Use” Lists Israeli import restrictions under the “dual use” list need to be sharply reduced to standard prohibitions. This list has prevented the private sector from importing capital equipment, renewing its depreciated technology and expanding its production, which has resulted in declining private sector investment and economic growth.

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V.

PROGRESS TOWARDS ESTABLISHING THE STATE AND ITS INSTITUTIONS

A. THE NEW NATIONAL PLAN – A FURTHER LEAP TOWARDS INTEGRATED PLANNING AND BUDGETING With the Palestinian National Development Plan (PNDP) 2011-13 coming to its close, the Government is focusing its energy on the successive planning phase, covering the period 2014-16. The process for the upcoming national plan is jointly led by the Ministry of Finance and the Ministry of Planning and Administrative Development, in which both execute a joint work-plan.

The upcoming plan will have similar components as the current one, but will differ in its process. Primarily, the new development plan for 2014-16 will be a further leap toward integrating planning with the budgeting process.

As outlined in previous AHLC reports, the Government has embarked on a transition from item-based budgeting to program-based budgeting over the past years. Programbased budgeting essentially means resources for each budget entity will be allocated towards a small number of identified main deliverables. Each program is characterized by an objective, a set of activities, indicators, means of verification and a budget covering recurrent and non-recurrent financial requirements. For the first time, the programbased budgeting approach integrates required development financing (investments are commonly covered by external development financing) with budgetary financing. Required development financing will thus be extracted out of the overall program-based budget, rather than being drawn-up in a parallel process.

Once again the national development plan for 2014-16 will be underpinned by 23 sector strategies. Line ministries in charge of existing sector strategies will lead the process for the second generation of sector strategies and are strongly encouraged to elaborate their strategies in a cooperative manner, with the help of inclusive sector strategy teams.

Altogether the 66 budget entities are expected to draft around 160 – 165 programs (with an average of 2-3 programs per budget entity). These programs are being inserted directly into the MoF’s integrated financial management information system. Thus, once the budget ceilings are approved, the programs automatically become the basis for budget execution. A manual for program-based budgeting was developed and distributed to assist budget entities in the preparation of their respective programs.

With the full operationalization of the Macro Fiscal Unit at the Ministry of Finance, the plan and the budget will be guided by a sound medium-term fiscal framework covering three years.

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The integration of the planning with the budgeting process implies further that the planning process is synchronized with the budget calendar. Accordingly, by the end of December, the budget for 2014 will be approved alongside the development plan for 2014-16.

There are also challenges ahead in the execution of program-based budgeting; particularly the ability of line ministries to monitor and evaluate the implementation of the programs along their defined set of indicators. While a few budget entities, with the help of MoPAD, already have advanced M&E systems, others will need more time to develop their monitoring and evaluation frameworks.

B. DONOR SUPPORT TOWARDS PALESTINIAN STATE BUILDING Since the inception of the Palestinian National Authority in 1994 our international partners have been extremely supportive of Palestinian efforts to establish functioning institutions. Over the past year the Government of Palestine has consistently called for a more integrated approach across the political and development realm, particularly in those areas of Palestine known as “Area C,” in line with the two-state solution. The response of our international partners has been encouraging and has re-instilled hope that the international community is indeed committed to the creation of the State of Palestine and stability in our region.

The advocacy efforts by the Government of Palestine resulted in donors’ awareness and recognition of the importance of engaging in so-called “Area C” as a mean of preserving the option of a viable State of Palestine. Major sectors for investment in “Area C” currently include local governance, water & waste water, community infrastructure (schools and health centers), energy, the cluster of agriculture, livestock and food security, as well as protection. The engagement in “Area C” covers bilateral donors as well as multilateral donors who have developed comprehensive packages for “Area C.” The Government of Palestine formulated and developed several mechanisms and arrangements to implement projects in so-called “Area C,” including East Jerusalem; all of which are based on our national priorities to ensure national ownership. New mechanisms include Facilitating Access to Infrastructure Resilience (FAIR) and the Community Resilience and Development Program (CRDP). Further, we are utilizing existing programs, such as the Municipal Development and Lending Fund (MDLF), to strengthen communities in “Area C.” For further guidance on engagement in “Area C,” the Government intends to issue a separate engagement strategy for “Area C” before the end of the year. This “Area C” strategy paper will complement the national development plan for 2014-16.

Within this report we intend to present an example of best-practice engagement in “Area C”:

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The European Union – “Area C” and Palestinian State Building In full recognition of the close linkages between “Area C” and the preservation of the two-state solution, the European Union and its member states adopted a strategic and focused approach towards “Area C.” In July 2011, EU Heads of Mission in Palestine prepared a report entitled, “Area C and Palestinian State Building,” that identifies the steady growth of Israeli settlements and the restrictions imposed on Palestinians in “Area C” as a threat to the two-state solution.

The report recommends encouraging Israel to change its policies in “Area C” as well as working towards reducing the vulnerability of Palestinian communities in “Area C,” encouraging economic development and increasing visibility and accountability for the delivery of aid to “Area C.” Since 2012 the EU and EU member states have increased their already significant support to the Palestinian population in “Area C” (including East Jerusalem) across the following sectors: agriculture, urban planning, health, education, water, solid waste, energy, housing, cultural heritage and tourism and private sector development. In addition, the EU and its member states are supporting civil society organizations to providing legal aid and other forms of protection for Palestinian communities in “Area C” (incl. East Jerusalem). Altogether around EUR 55 million have been allocated for programs and projects to support the Palestinian population in “Area C.” This approach is complemented by cross-cutting technical/political initiatives such as the recent publication of EU guidelines for the award of EU funding to Israeli entities. In these guidelines the EU clearly states that it does not recognize Israeli sovereignty over the West Bank, including East Jerusalem, the Gaza Strip, and the Golan Heights, and accordingly does not channel any funding to Israeli institutions within these areas. The EU’s approach is thus a prime example of an integrated intervention that covers political and development engagement.

The Government of Israel’s resistance is formidable: Since 2009, the European Union and its member states have invested in master plans for Palestinian villages in “Area C.” Starting in July 2011, 42 such master plans have been submitted to the Israeli Civil Administration. As of September 2013 not a single plan has received approval. In addition, the EU estimates that since 2011 some 200 European-funded structures in “Area C” have been demolished by Israeli authorities. In a latest move, the Israeli Ministry of Defense has ordered the defense establishment to cease cooperating with EU projects and representatives in the West Bank, including EU infrastructure projects in “Area C.”(34) Despite the Government of Israel’s policies of obstructing and destroying these initiatives, the EU’s approach is of paramount importance to preserving the viability of the two-state solution.

34 Jonathan Lis, “Bennett urges Israeli government to cut ties with EU over settlement guidelines,” Haaretz, 6 August 2013, http://www.haaretz.com/news/diplomacy-defense/.premium-1.539959.

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In recognizing the valuable efforts of our international partners to support Palestinian state-building, we would also like to point out areas of cooperation where our partners currently do not live up to their international commitments in delivering aid in the most effective manner.

The Public Expenditure and Financial Accountability (PEFA) framework assessed certain aspects of donor performance, particularly in relation to their impact on the Government’s public finance management system.

While the PEFA assessment recognizes strong progress in donors providing detailed and comprehensive budget support forecasts, it also points out enormous deficiencies in donor forecasting and reporting on development programs and projects. According to the PEFA report, “the provision of information to the government is neither comprehensive, nor detailed, nor timely, nor accurate.” As we emphasized in the past, the lack of information on donor-funded programs and projects severely impedes the ability of the Government to plan, to allocate resources, and to coordinate support. Thus, we would like to point out once again the importance of utilizing the DARP platform at the Ministry of Planning and Administrative Development (MoPAD) to register all aid programs and projects.

Similarly, the PEFA assessment determined that the proportion of aid managed by national systems is very low. Utilization of national systems is not even the standard procedure for financing recurrent costs (budget support and quasi budget support) among some donors and is rarely exercised for the implementation of regular development programs and projects. We urge our international development partners to carefully consider the option of utilizing national systems for each and every project – as per the commitments made at successive High Level Forums on aid effectiveness. The Palestinian government stands ready for dialogue with all parties on practical arrangements and encourages the expansion of joint financing mechanisms utilizing national systems, as currently applied for support to the education sector.

The PEFA findings fully correspond with the findings of the Paris Declaration Monitoring Survey conducted in 2011 and re-emphasize the need for increased donor efforts on reporting to DARP and for more flexibility on financing arrangements involving national systems.

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