Even during the worst previous periods of conflict, a majority of hard-working Palestinians managed to remain in employment, and the West Bank and Gaza economy continued to function. But the economy has imploded since the radical Islamist party Hamas won control of the Palestinian Authority (PA) government after elections in January, and international partners cut their funding.
With the quiet authority of an academic economist and three decades IMF staffer, Palestinian Monetary Authority (PMA) governor George Abed spelt out to Emerging Markets the extent to which the political fallout of Hamas’ victory has sucked the oxygen out of the Palestinian economy, potentially fatally undermining the PA, led by the Fatah party president Mahmoud Abbas (known as Abu Mazen).
GDP is estimated to have plummeted by 22% in the first half of 2006. “In the last six or seven months [since Hamas took over the government], poverty has risen to over 50% in Gaza, which is unusual for Palestine … and unemployment, which was probably 24-25% towards the end of 2005, is now around 40% in Gaza and 30-35% in the West Bank, and growing,” Abed says.
With Israel regularly blocking off the territories for “security reasons” and the “international community” stopping payments to the Hamas government, the outlook is bleak. “If this situation continues, we will soon see signs of stress,” Abed says: “It is getting very difficult to hold – in Gaza people are just scraping by.” The bottom line is that “with further deterioration, we’ll have an economic implosion, more violence and the PA could collapse.”
The West cut off most aid to Hamas in protest at its refusal to recognize Israel’s right to exist, to renounce violence or accept previous agreements in the moribund “peace process”. One glimmer of light has come with signs that Hamas’ internal leadership might moderate its stance and even work with its rival, Fatah. To engineer this, Abbas instigated moves to create a national unity government, after Hamas produced a document on prisoners that was taken as implicit recognition of Israel. But these moves have apparently failed.
Abbas must negotiate this difficult cohabitation, while keeping open lines of communication to Israel and the US, whose Bush administration still wants him to dissolve the elected Hamas government. The latter is coming under pressure closer to home, with a spate of strikes by state-sector workers over the government’s failure to pay salaries. Labour unions have announced action involving some 80,000 workers, including 37,000 teachers and 25,000 health workers.
Some payments have been made – with funds occasionally coming into Gaza illicitly from money provided by Hamas supporters abroad, and channelled into the territory by the external leadership, headed by Damascus-based Khalid Mishaal. These funds give Gaza’s economy a short-term bounce, Abed concedes, but they are kept well outside the banking system.
No terrorist financing
Keeping the banking sector functioning and as safe as possible from charges of abetting terrorist financing is a critical issue. “The 21 Palestinian banks have proved surprisingly resilient and in good health through all these problems,” Abed says.
Capital flight has been limited, and banks’ performance has improved over the past year. In April 2005 the banks’ total capital was $278 million, but this had risen to $414 million by end-year, and Abed forecasts a $474 million end-2006 figure. Backed by solid collateral, banks have rescheduled business loans as the Hamas effect has bitten into Palestinian companies’ bottom lines.
Deposits – at around $4.4 billion in 2005 – have stagnated, but at a time of deep crisis and an “implosion of government finance”, there has been no run on the banks. “People still think there is no reason to move their money to Israel or Jordan,” Abed says. Of the regulator he joined in April 2005 at Abbas’ request, the IMF veteran says, “The PMA has been vigilant and relatively competent” – which has helped banking to be “probably the only sector that looks normal” in an economy stretched to breaking point.
Abed says he had several offers after retiring from the IMF but took on the toughest, the PMA, at the personal request of Abbas – a politician he admires. “There was an opportunity to do something positive, because whereas [the late Palestinian leader] Yasser Arafat was allowed to micro-manage by the previous government, putting huge pressure on governors, Abu Mazen has given leeway for the PMA to act independently.”
This independence will be enshrined in changes to the PMA’s founding law, which will enshrine international best practice: the European Central Bank charter is a model. The legislation will include anti-terrorist financing and money laundering clauses, which is especially important because of the international scrutiny on Palestinian banks – who no longer even handle government finances to avoid being associated with Hamas.
As all Palestinian trade passes through Israel, the PMA has had to work hard to persuade major Israeli banks to work with it. Abed points out that this is essential as it involves some $2.8 billion of imports, financed on Israeli letters of credit, and the financing of Palestinian exports – when the Israeli authorities deem it appropriate for them to pass its frontiers, rather than being left to rot, as is all too often the case for agricultural products.
Trust fund
Western bankers observe that financing deals in the region remains very problematic. A trust fund, designed by European Union experts drawing on the experience of similar arrangements set up by the World Bank and UN agencies for post-conflict countries, has been designed get around political obstacles, offering donors a route for channelling money to public service workers without directly giving it to the Hamas-run central administration. But although the US agreed to the idea in principle, in talks with other members of the Quartet (the EU, Russia and the UN), it failed to make the practical regulatory changes that would allow banks to send money to the fund or handle payments from it, and so far the idea has remained on the drawing board.
Arab Bank, chastened by its US experience, told the PA it would no longer host its Central Treasury Account; other banks have been wary of stepping into its shoes, and although the PMA could technically act as a financial agent for the PA, Abed tells Emerging Markets this had been ruled out. The PMA must remain independent so Palestinian banks can ride out the current storms, leaving a more enduring legacy for a very uncertain future.