Hopes of a two-state solution fade

22 June 2014

The Fatah-Hamas pact reflects the Palestinian Authority’s view that building domestic unity will generate more rewards in the long-term than a US-brokered deal with Israel

US-sponsored efforts to revive the faltering Israel-Palestine peace process came to an end in late April, as the nine-month deadline set by Washington for reaching an agreement passed without any material progress towards a settlement.

Israel declared a formal end to talks with the Palestinians on 24 April, following the previous day’s announcement of a unity government formed between Fatah and Hamas, the rival political factions that control the West Bank and Gaza respectively. In Tel Aviv’s view, there was no point in continuing negotiations with a Palestinian partner that included the “terrorist” Hamas movement.

Untenable deadline

In any case, few had invested much hope in a deal being reached according to US secretary of state John Kerry’s preferred timetable. And while the prospect of a two-state solution has faded further into the distance, there is an upside for the Palestinians in that the damaging disunity between the rival political factions has been papered over, for now at least.

GDP 2012
SectorPer cent
Wholesale and retail trade, motor repairs16
Public administration and defence13
Mining, manufacturing, power and water13
Information and communication8
Agriculture, forestry and fishing5
Finance and insurance4
Transport and storage2
Source: Palestine Investment Promotion Agency

The Fatah-Hamas pact envisages the formation of a technocratic unity government that will prepare for elections within a six-month timeframe – the first elections to the presidency and Palestinian legislative council 2005-06.

Many Palestinians will hope that this settlement sticks; past performance is not encouraging, with a similar unity pact in 2011 unimplemented.

The decision to go for a deal with Hamas, rather than pursue a US-brokered deal with Israel, reflects the Palestinian Authority (PA) leadership’s view that building domestic unity would in the long-term generate more rewards than stitching a deal together with Binyamin Netanyahu’s government, whose commitment to peace always looked questionable.

Main focus

The process of forming a unity government will take up much of the participants’ time in the next few months, leaving little prospect of new government-led economic initiatives. Neither will the collapse of peace talks do much to facilitate a revival in foreign donor support.

The damaging disunity between the rival political factions has been papered over, for now at least

Prior to the Fatah-Hamas deal, the PA had pushed a reform agenda that yielded dividends; for example, approving a new revenue strategy and action plan with an emphasis on tax policy and enforcement measures. The income tax law has also been amended to introduce a 10 per cent tax on distributed dividends, while a procurement law and associated implementing regulations gained cabinet approval. The latter, notes the World Bank in its Palestinian Reform Development Plan Trust Fund review for the first quarter of 2014, represents a key reform that will enhance the transparency and efficiency of the overall public financial management system.

Other recent reforms are designed to bolster the investment climate, with the enactment of a leasing law intended to encourage new forms of business financing. In February 2014, PA finance minister Shukri Bishara announced a number of fiscal policy changes, including a reduction in property tax and measures to broaden the tax base.

Healthier finances

There is also evidence of greater effort to contain spending, with a zero net hiring policy for 2014. State finances look in better shape than a year ago. According to the World Bank, domestic tax revenues performed well in the first quarter of 2014, growing by 24 per cent on the same period in 2013.

The higher than expected revenues and lower than anticipated expenditures meant the PA’s total deficit, amounting to $289m in the first quarter of 2014, was 31 per cent below its budget target and 12 per cent lower than in the first quarter of 2013.

International donors have shown greater reticence to continue funding the Palestinian Authority

That still leaves the PA facing a sizeable budget deficit of an expected $1.6bn for the year. The 2014 PA budget, approved in February, sees spending rising by 9 per cent over 2013, reaching $4.2bn – about half of which is earmarked for PA salaries. Revenues of $2.7bn are expected for 2014.

One concern for PA policymakers is that international donors have shown greater reticence to continue funding the PA. According to the Washington-based IMF, recurrent deficits, combined with weaker donor support, has left the PA reliant on short-term domestic financing. Palestinian GDP growth has slowed. Having averaged 8.2 per cent annual growth in the 2006-11 period, for this year, the IMF forecasts just 2.5 per cent GDP growth.

Gaza/West Bank key economic indicators
Population (millions)
Nominal GDP ($bn)
GDP per capita ($)1,6331,7102,0612,3452,3892,5742,7202,8462,954
Real GDP growth (annual change, %)
Total government debt (gross, % of GDP)26.428.725.933.537.537.437.737.536.8
Current account balance (% of GDP)12.2-10.6-10.6-23.6-28.9-22.4-21.0-18.2-16.1
Unemployment (%)
Inflation (%)-
f=Forecast. Sources: IMF; UNCTAD; Palestine Central Bureau of Statistics; World Bank

Hamas-ruled Gaza remains under an Israeli economic blockade, made worse by the aftermath of Egypt’s political change in summer 2013. The ousting of Muslim Brotherhood president Mohammed Mursi has entailed negative consequences for Gaza’s economy, with a crackdown on tunnel smuggling activity instituted by Field Marshal al-Sisi’s regime. Gaza’s utility firm has been forced to buy more expensive fuel from Israel, because of restrictions on cheaper Egyptian fuel.

Potential upgrade

More upbeat news arrived in December 2013, with the announcement by index provider S&P Dow Jones that it is considering adding the Palestine Exchange to its suite of frontier market indices. The bourse is now on the watchlist for potential inclusion in the S&P Frontier BMI and Dow Jones Total Stock Market indices.

If the upgrade comes, Palestinian stocks stand to gain from an inflow of passive foreign investment funds.

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