The financial destruction of Palestine

Ahead of the recent G7 summit, US Treasury Secretary Janet L. Yellen, in a rare rebuke of Israel, warned that its plans to cut off Palestinian financial institutions from the global banking system would threaten the West Bank's economic stability. But her warning may have come too late to stop Israel's far-right finance minister, Bezalel Smotrich, who seems bent on undermining the last vestiges of the Palestinian Authority's (PA) already-limited self-governance in the West Bank.

The sanctions that Smotrich wants to impose – specifically, revoking the waiver that allows Israeli banks to facilitate transactions with Palestinians without fear of legal action – are in response to Ireland, Norway and Spain formally recognising a Palestinian state. Ironically, the PA is on the verge of collapse, owing to Israel's actions and the world's inaction.

Yellen seems to understand that Smotrich's plan to sanction the PA cannot be attributed solely to the ideological underpinnings of the most annexationist government in Israel's history. They are also indicative of an isolated Israel doubling down on its offensive in Gaza even as global pressure to end the war intensifies. But perhaps Yellen should bring her legitimate concerns about the PA's financial solvency to US President Joe Biden, given his staunch support for Israel, before expecting other countries to take up the cause.

While the international community has recently expressed concern about the West Bank's looming economic catastrophe, the Palestinians living there (and elsewhere) remain fixated on the war in Gaza – already a catastrophe in every way. 

In fact, few informed observers have been surprised at the scale, intensity and speed with which the war's economic fallout has hit the West Bank and the PA, given their deep dependence on Israel for jobs, trade and currency. This asymmetrical relationship has been forged over decades of occupation, characterized by a constant struggle for land, resources and rights, and increasing violence by extremist Israeli settlers, who have long enjoyed impunity.

Part of the dependency dynamic involves Israel collecting and clearing customs and import taxes on behalf of the PA. So, when faced with European efforts to build momentum toward a political settlement of the crisis, Smotrich decided to seize these tax revenues, in addition to threatening new financial sanctions. Before the war, the PA was entitled to an average of $270 million per month in total clearance revenues – enough to cover the salaries of 147,000 civil servants, its most essential current expenditure.

But for many years, Israel has made unilateral deductions, starting with unpaid utility and health bills owed to Israeli providers (based on government calculations). Since 2018, it has also deducted payments made to families of people whom the PA deems martyrs and to families of people imprisoned in Israel. 

By the end of 2023, these additional deductions amounted to around $1.2 billion. This does not include deductions for unpaid utilities, health bills and other deductions called "net lending," which totaled $662 million in 2023 alone.

After the 7 October attack on Israel by Hamas, Smotrich began deducting the amount that the PA spends on staff and pensioners in Gaza. By April 2024, these deductions, coupled with a steep decline in private consumption and imports, left the PA with under $100 million per month in "eligible" revenues, around a quarter of its monthly budget.

Smotrich has threatened to freeze the transfer of that amount and any clearance funds, while also pushing legislation to expropriate the deducted funds – which have been held in escrow accounts – to finance Israel's war deficit. 

In yet another Israeli twist of the financial screws, the Bank of Israel has yet to accept the periodic exchange of accumulated stocks of Israeli shekels with Palestinian correspondent banks for foreign currency as stipulated under the Oslo Accords. This has led to panic among clients unable to deposit Israeli shekels. Meanwhile, the PA's salary arrears have reached at least six months. And that is only part of its $8 billion public debt, which is around 60% of West Bank GDP. 

Hence, the PA is facing imminent fiscal collapse, with the West Bank "on the brink, risking an explosion any time," as the normally cautious Palestinian Prime Minister Mohammad Mustafa recently put it.

The G7 leaders and the Ad Hoc Liaison Committee, an international donor group for Palestine that met last week, must heed this warning as they consider making far-reaching decisions that could be as momentous as the war's outcome. Moreover, policymakers should be clear-eyed on what can and cannot be done. It is absurd to demand that the PA implement reforms, build state institutions, reconstruct Gaza, and police its people while Israel simultaneously withholds its main source of finance.

In the early days of Biden's presidency, some Palestinians, still reeling from the hostility of the Trump era and without a viable path to independence, hoped that he might push for Palestinian rights. In 2021, I proposed a US-sponsored financial New Deal for Palestine, which would reinforce the PA fiscal position, without requiring US diplomatic recognition of Palestinian statehood. The idea would be to grant Palestine formal status or reach an ad hoc arrangement at the International Monetary Fund so that it can tap international financial assistance like any other developing country, a small step towards sovereignty.

Implementing this plan is more important than ever. 

If the countries that have recognised Palestinian statehood – either recently or in the past – want their declaration to be more than a symbolic gesture, they must start treating Palestine as the state it will eventually become. And if the United States wants to prove that it is more than an accessory to Israel's war, it must lift its veto on Palestine's bid to become the state it deserves to be. 

The march toward Palestinian fiscal sovereignty is inevitable, but it must happen sooner rather than later.

Raja Khalidi is the Director-General of the Palestine Economic Policy Research Institute (MAS).

Disclaimer: This article first appeared on Project Syndicate, and is published by a special syndication arrangement.