PURSE REVIEW July - September 2024 Fiscal Performance 1. The Palestinian Authority’s (PA) fiscal position has considerably worsened since the eruption of the Middle East conflict in October 2023, and the ensuing economic recession. The Palestinian economy is estimated to have contracted by 28 percent in the first three quarters of 2024, with Gaza falling in a deep recession shrinking by 82 percent, and the West Bank declining by 19 percent.1 As a result, the PA’s total domestic revenues dropped by 27 percent over the same period, year-on-year (y/y), following a decline in all tax and nontax categories. On the clearance revenue front, collections dropped by 19 percent during the same period because of a slowdown in trade. On top of this, increased deductions by the Government of Israel (GoI) further reduced clearance revenue transfers. Monthly Israeli deductions from clearance revenues surged to around NIS500 million since October 2023, up from an average of NIS200 million prior.2 As a result, the net amount of monthly clearance revenues transferred to the PA was significantly reduced, depriving the PA from full access to its main source of income for over a year and crippling its ability to provide services and pay public salaries. 2. The PA does not have tools available to other governments to deal with the significant revenue drop and is not able to access international markets, so it rationed spending. As a result, public spending declined by 3 percent in the first nine months of 2024, on a commitment basis, driven by a drop in most major spending categories. In fact, the wage bill, the largest spending item, dropped by 1 percent on a commitment basis. However, on a cash basis, the PA paid, on average, only 70 percent of the salaries of its public employees in Q2 and Q3 2024, up modestly from lower rates in the previous months, while protecting the lowest earners. Spending on goods and services and transfers also dropped by 16 and 9 percent, respectively, due to the lack of funds. In contrast, net lending increased by 16 percent reflecting additional unplanned subsidies to Local Government Units (LGUs) covering accumulated utility bills to the Israeli suppliers due to a worsening of the economic situation. Further, the PA’s interest payments increased by 30 percent given the rise in domestic borrowing to finance spending. 3. The decline in expenditure in the first nine months of 2024 was not commensurate with the revenue drop, resulting in the PA’s inability to finance its needs. Fiscal space has been recently shrinking due to the conflict and its impact on revenues, the withholdings of higher clearance revenues and the difficulty to significantly cut spending amid a slowing economy. The total deficit (before grants) amounted to US$872 million in the first nine months of 2024. Donor financing increased during the same period, y/y, and reached US$459 million (US$394 million allocated for budget support and US$65 million for development financing), up from US$231 million in the first nine months of 2023 (see Table 1). Despite the increase in donor financing, the PA’s deficit reached US$413 million in the first nine months of 2024. Taking into account Israel's deductions from clearance revenues, the financing gap widened to US$964 million. As in previous years, the gap 1 According to latest official data by the Palestinian Central Bureau of Statistics (PCBS). 2 This increase was mostly intended to account for the PA's unchanged spending in Gaza. 1 was covered through the accumulation of arrears and borrowing from domestic banks. The total stock of arrears owed to the private sector stands at US$1.3 billion and arrears to public employees equal US$1.46 billion. The PA’s total public debt increased from US$3.78 billion in December 2023 to US$4.1 billion as of September 2024. Table 1: External financing to the PA’s budget, million USD Jan-Sept 2023 Jan-Sept 2024 Total External Financing 231.1 458.7 1. Budget Support 155.6 393.8 A. Arab Donors 5.4 125.2 Of which Algeria 0 105.5 Iraq 5.4 19.6 B. International Donors 150.2 268.7 Of which Norway 0 9.3 France 0 8.6 PEGASE 88.5 176.5 World Bank 61.7 74.3 2. Development Financing 75.5 64.9 Of which Co - Financing for Projects of MOEd 0 1.9 APAS (PEGASE) 1.5 0 Old Grants for Line Ministries 26.6 14.7 Others 47.5 48.3 Source: PA Ministry of Finance Note: In 2024, financial support from Norway and France was provided bilaterally, while it was provided through the World Bank’s Trust Fund in 2023. Reform Progress 4. The assessment in this section is based on progress made by the PA in achieving the targets set in the World Bank’s Development Policy Grant (DPG) 13 approved by the Board of directors on March 17, 2023. This is the thirteenth budget support operation that the World Bank has prepared for the benefit of the Palestinian people, and it is in the amount of US$30 million. The development objectives of the operation are to: (i) improve the structural fiscal balance and strengthen the effectiveness of public procurement, and (ii) strengthen the integrity of the financial sector and pursue digital transformation. It is important to note that the targets set in the DPG assumed the continuation of a pre-conflict status quo that would allow the PA to maintain efforts to achieve the targets within the set timeline. However, the exceptional circumstances created by the conflict, the worsening fiscal crisis and increased access and mobility restrictions in the West Bank have played a key role in hampering the PA’s ability to achieve some of the DPG targets. The following table summarizes implementation progress while the section describes progress to date. Table 2: DPG 13 Implementation Progress Prior Action Implementation Progress Pillar 1 Prior Action 1 On track 2 Prior Action 2 Achieved in civil sectors Off track in security sector Prior Action 3 Off track Pillar 2 Prior Action 4 On track Prior Action 5 Achieved Prior Action 6 Off track Pillar 1: improve the structural fiscal balance and strengthen the effectiveness of public procurement 5. Prior Action 1: To improve revenue mobilization and reduce tax evasion, the Recipient, through its revenue directorate at the Ministry of Finance, will strengthen cross checks on VAT invoices by mandating businesses to use an online portal to submit their monthly VAT invoices for purchases and sales to be reconciled with those submitted by other businesses, as evidenced by instructions by the Director General of revenues issued on October 30, 2022. Building on initiatives outlined in previous DPGs and to further enhance public revenues, this prior action supports the PA’s ongoing efforts to combat tax evasion. The MoF has introduced an online portal mandating businesses to submit their domestic VAT invoices for both sales and purchases. The system automatically cross-checks these submissions to ensure alignment between the information reported by selling businesses and that provided by buyers. The agreed-upon target with the MoF for this prior action is to increase the share of domestic VAT collection to domestic tax revenues from 37 percent in 2022, to 39 percent in 2024. Between January and September 2024, the average reached 42 percent according to the MoF data, exceeding the DPG target. The MoF emphasizes its full commitment to the reform, conducting regular audits and follow-ups in cases where cross-checks reveal discrepancies to address potential tax evasion. This commitment has sustained a high collection rate that is expected to be maintained. 6. Prior Action 2: To renew the impetus on wage bill reform, the Recipient, through its cabinet, has: (1) adopted an attrition target for net public employment whereby yearly civil and security personnel appointments do not exceed 50 percent of retirement-related and other kinds of departures from the PA during the same year, as evidenced by Cabinet decision No. (18/181/01) dated November 14, 2022, and (2) requested all government agencies to assess their Human Resources (HR) needs and skills, on a yearly basis and submit a list to the Cabinet identifying employee surplus and shortages of skills, with the purposes of reallocating and/or training surplus employees, to enhance efficiency, as evidenced by Cabinet decision No. 18/178/19 dated October 10, 2022. Over the last decade, the PA’s wage bill averaged 14 percent of GDP and 46 percent of central government expenditure – higher than all comparators. In light of escalating fiscal constraints, the PA has recommitted itself to wage bill and public employment reform. One of the initial reforms implemented by the PA in this regard was the decision to set an attrition target for net public employment in 2023. The objective was to ensure that recruitments do not exceed 50 percent of the number of retirement-related and other departures 3 from the PA. This marks a departure from policies observed in recent years, during which annual net staff increases were witnessed. Data from the MoF’s payroll department for 2023 indicates that the ratio of recruitments to exits in the civil sectors was 67 percent. However, when short-term and daily contracts are excluded, and only permanent staff are considered, the ratio drops to 49 percent—slightly below the target agreed upon in the DPG. In the security sector, the ratio of hires to exits reached 132 percent in 2023. The PA explains that efforts to control hiring were not fully extended to this sector, considering the economic downturn, the deteriorating security situation, especially after the outbreak of the conflict, and the PA's role as an employer of last resort while the private sector remains constrained. However, the PA affirms its commitment to this reform and plans to extend efforts to the security sector once the situation on the ground improves. 7. Prior Action 3: To improve the professional quality of procurement staff in the Palestinian Authority, and enhance the effectiveness of public procurement, the Recipient, through its Cabinet, approved the “Procurement Capacity Building and Professionalization Strategy� which recognizes procurement as a distinct profession in civil service, institutes a permanent procurement training program and establishes an independent certification mechanism for procurement staff, as evidenced by cabinet decision No. (18/186/03) dated December 19, 2022. Building on reforms outlined in prior DPGs, this initiative reinforces the PA’s commitment to advancing public procurement reform. With the aim of improving public resource management and accountability, the PA is placing a high priority on enhancing the professional quality of procurement staff through a certification process based on the PA's 'Procurement Capacity Building and Professionalization Strategy.' This strategy was prepared by the Higher Council for Procurement Policies (HCPPP) with support from the World Bank, in close collaboration with the General Personnel Council (GPC) and other stakeholders. The target for this prior action is that 80 percent of public procurement staff will have completed the training program by December 2024, up from 0 percent in December 2022. The HCPPP has signed a contract with the European Institute for Purchasing Management (EIPM) on July 31, 2024 to support the development of the procurement training modules and the contract implementation is underway. The work with the EIPM is progressing well. EIPM has commenced the development of the training modules outlined in the strategy, with an expected completion date of April 2025. The HCPPP regular training program, which includes some of the training modules developed by the HCPPP and will be integrated into the overall training program being developed by the EIPM, continues but at a slow pace due to the prevailing security conditions. The DPG target was not achieved by the end of 2024 (see Table 2). Table 2: Public Procurement Trainees (as of December 2024) No. of Trainees No. of Trainees from Public Total No. of % out of the Total Training Topics from PA Central Institutions/Municipalities Trainees Procurement Staff Agencies Public Procurement Law 263 241 504 39.2% (PPL) Single Procurement Portal 241 238 479 37.3% (SPP) Standard Bidding 470 312 782 60.9% Documents (SBDs) Contract Management 76 0 76 5.9% Procurement Planning 98 77 175 13.6% 4 * The total number of public procurement staff in the PA Central Agencies and the Local Government Units (LGUs) is 1,285 procurement staff (530 for the PA Central Agencies, and 755 for the LGUs). Source: HCPPP Pillar 2: strengthen the integrity of the financial sector and pursue digital transformation 8. Prior Action 4: To modernize the Anti-Money Laundering and Combating Financing of Terrorism legal framework, and to align it with international best practices, the Recipient, upon recommendation of the Council of Ministers on July 4, 2022 and through its President, enacted a new AML/CFT law No. 39 published in the official gazette No. 193 on August 14, 2022, and AML/CFT instructions for financial institutions licensed to operate in the Palestinian territories, as evidenced by Instructions No. 2, issued by the National Committee for AML/CFT and published in the official gazette No. 192 of June 30, 2022. The Palestine Monetary Authority (PMA) and the Financial Follow-up Unit have been working to enhance the Palestinian Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) regime to align it more closely with international practices. In 2018, the local authorities conducted their initial self-assessment to strengthen the capabilities of relevant AML/CFT stakeholders in identifying, assessing, understanding, and mitigating money laundering and terrorism financing risks. The assessment received official endorsement from the Palestinian Cabinet in October 2018, followed by the Cabinet's adoption of the national AML/CFT strategy in November 2018. In 2022, with technical assistance from the International Monetary Fund (IMF), the authorities enacted a new AML/CFT law (No. 39/2022) and issued instructions (No. 2/2022). These defined "beneficial ownership transparency" for account holders and established systematic procedures for financial institutions to collect, verify, and maintain beneficial ownership information. The agreed-upon target for this prior action is for the PMA to conduct on-site inspections of licensed banks, accounting for 85 percent of total bank assets, to ensure compliance with the new procedures on beneficial ownership information by December 2024. As of December 2024, on-site inspections have covered a total of 10 out of 13 banks, collectively representing 90 percent of the total assets in the banking sector, exceeding the DPG target. The PMA remains committed to this reform, and efforts are expected to continue to encompass all banks. 9. Prior Action 5: The Recipient, through the Palestine Monetary Authority, further advanced the digital transformation agenda in the financial sector and enhanced public confidence in electronic transactions by enacting a national payments law regulating the use of e-money and strengthening the PMA’s authority over entities providing e-money services, as evidenced by presidential decree No. 41 dated August 8, 2022, published in the official gazette No. 193 on August 14, 2022. This DPG supports the PMA’s initiatives to advance the digital finance legal framework through the adoption and implementation of a new national payments law. The purpose of this new payments law is to bridge the gap between banks and non-bank market players, while also strengthening the PMA's licensing and supervisory authority over entities providing e-money products and cashless payment services. Additionally, it aims to establish a level playing field in the retail payments market, ultimately benefiting end-users through increased competition and innovation. This, in turn, facilitates market entry and the deployment of various e- money-based services and products, addressing the needs of vulnerable and financially excluded 5 population segments. The target for this prior action is to achieve a 150 percent increase in the number of cashless transactions by December 2024, compared to a baseline of 2,059,229 cashless transactions in June 2022. According to the latest data from the PMA, cashless transactions have already increased by 173 percent, with a total volume reaching 5,613,288 transactions, exceeding the DPG target. 10. Prior Action 6: To support women empowerment through financial inclusion, the Recipient, through the Palestine Monetary Authority, issued circular No. 201/2022 dated September 6, 2022, adopting a single definition for female-owned enterprises applicable to all Microfinance Institutions, and introducing the obligation to disclose the number and size of financing provided to these businesses on a regular basis, in order to strengthen the role of MFIs in supporting women. This DPG supports the development of the data infrastructure needed to advance the financial inclusion of women through targeted gender outreach and evidence-based programming. These efforts aim to encourage financial institutions to increase the share of women- owned businesses in their respective portfolios. The target for this prior action is that 1,500 women- owned businesses, according to the new definition, have access to microfinance by December 2024. According to the latest data from the PMA, 794 women-owned businesses accessed microfinance institutions as of December 2024, a decline from the September figure of 924. The PMA reports that progress on this indicator has been severely affected by the outbreak of the conflict and its impact on the economy. Hence, the DPG target was not achieved. 11. To conclude, 2 out of 6 prior actions remain on track, 1.5 already achieved while the achievement of 2.5 has been delayed. The exceptional circumstances created by the conflict, the worsening fiscal crisis and increased access and mobility restrictions in the West Bank have played a key role in hampering the PA’s ability to achieve some of the DPG targets. Hence, not all the targets were achieved within the set timeline and the recent deterioration of the security situation in the West Bank is expected to create additional challenges. 6