The Palestinian government was confronted with a severe fiscal crisis in 2006. Resources to fund the government's recurrent expenditures fell by more than one third compared to the previous year, despite a strong increase in external support, forcing a major compression of expenditures. Government employees received on average only about 50-55 percent of their regular incomes. As new financing mechanisms were set up to bypass the government and banks were reluctant to transact with the government, the public financial management system became increasingly fragmented, with no proper budget framework, no central control, and less transparency and accountability. At the same time, the PA's already unsustainable underlying fiscal position deteriorated further in 2006. The government's wage bill continued to expand and now exceeds revenues (adding the indirect tax revenues still withheld by Israel). Strong adjustment will be needed to put government finances on a sustainable path, but sizable external support will remain needed in the adjustment period. A strong economic recovery would greatly assist the adjustment process.
I. INTRODUCTION
1. This note provides an overview of the fiscal outturn in 2006.(1) Fiscal developments in 2006 were largely shaped by the domestic and international political difficulties that followed Hamas' victory in the January 2006 parliamentary elections. After the first quarter of 2006, resources to fund recurrent government expenditures fell sharply. As a result, the Palestinian Authority (PA) government was unable to pay full wages and faced increasing pressures to reduce non-wage expenditures and transfers, while also building up arrears. This situation has contributed to a deepening in the PA's fiscal difficulties, which were rooted in the unsustainable policies, including a rapidly expanding wage bill and large budget transfers to cover losses from the production and consumption of energy and utilities. At the same time, the crippling of the Palestinian economy, including through restrictions on movement and access, further reduced the government's ability to mobilize domestic revenues, put added pressure on the labor market in Gaza, and contributed to a further decline in collection rates of utility fees. In this note, fiscal performance is mostly discussed on a cash basis, with some reference to revenues and expenditures on a commitment basis, to emphasize the underlying trends. The note combines information received from the Ministry of Finance (MoF), the Office of the President, the Palestine Investment Fund (PIF), and from donors, to provide a consolidated picture of the central government's finances.(2)
II. FISCAL DEVELOPMENTS IN 2006
A. Public Financial Management System
2. The public financial management system suffered substantial damage in 2006. Much of the progress achieved in the years prior to 2006 to strengthen the MoF's control over government finances and increase transparency was lost.3 The system became increasingly fragmented as the MoF's Single Treasury Account (STA) was suspended, because of the reluctance of banks to transact with the government. Funds were routed through a variety of channels, outside the MoF's control, including via accounts of the Presidency and mechanisms set up by donors for the direct delivery of assistance to the Palestinian people. Funds were also brought in in cash through the Rafah border crossing. No proper budget framework existed in 2006, as formulating a budget had become a fairly meaningless exercise given the uncertainty about available resources.
3. With multiple spending centers and accounts, the MoF faced great difficulty in trying to reconcile various financial statements and ensuring that all resources and expenditures were properly accounted for. Regular reporting was interrupted during most of 2006. Only recently did the MoF issue reports on government finances in 2006, in which it aimed to provide a consolidated picture. The Office of the President-which had little alternative but to adopt a larger, albeit temporary, role in the coordination and management of a large part of the external assistance received in 2006, despite having a very limited capacity-has yet to present a full report on the funds channeled through its accounts.4 In addition, the MoF payroll department had difficulties in tracking all the payments made to PA employees from various sources, and may not have fully reflected yet all new staff hired by the government. Last, the recording of tax payments, which was previously done with the assistance of the Israeli Postal Bank, was interrupted in mid-2006, leaving the PA tax administration unable to properly monitor tax compliance and determine eligibility for VAT refunds.
Notes:
(1) See also "West Bank and Gaza: Recent Fiscal and Financial Developments", October 2006, which can be found at http://www.imf.org/wbg and which provided an overview of fiscal developments in the second and third quarter of 2006.
(2) This information includes MoF figures on amounts of external support received in cash. Additional amounts may have been received, as suggested by various press reports, but these are not reflected here.