IMF praises "bold" Palestinian economic reforms

WASHINGTON (Reuters) - The International Monetary Fund on Friday praised the Palestinian government's "bold" economic reforms, but said further headway was hobbled by border restrictions and failure to advance a peace deal with Israel.

"The persistence of Israeli restrictions and lack of progress in the peace process could inhibit economic activity, reducing private employment and household income growth," the IMF said in a report before a May 2 donor meeting.

It said the reforms, including stricter controls to rein in a ballooning civil service and wage bill, encouraged donors to fully cover the Palestinian Authority's financing needs for the first half of 2008, but a $400 million shortfall is projected for the rest of the year.

"The (IMF) staff considers that the reforms undertaken so far, and the 2008 budget, represent a significant stride toward fiscal sustainability," the IMF said.

In mid-2007, donor nations resumed aid flows to the Western-backed government of President Mahmoud Abbas, pledging $7.7 billion for the next three years to revive the Palestinian economy. But a weakening U.S. dollar had added to the financing gap for the 2008 budget, the IMF said.

The fund said the 2008 budget aims to cut the deficit to 22 percent of gross domestic product from 27 percent in 2007, through wage freezes on new employment, increases in utility payments and spending controls.

While there was progress, the IMF said on the ground conditions had not improved as expected, with a recovery in the private sector lagging and rising inflation cutting into incomes.

It said inflation hit 11 percent in the year to March, up from 4 percent in September 2007. It was worst in Gaza, at 16 percent, and the West Bank, at 9 percent, amid Israeli border restrictions and rising global grain and fuel prices.

The IMF said tightened Israeli border restrictions would hamper further economic progress.

"The persistence of Israeli restrictions and lack of progress in the peace process could inhibit economic activity, reducing private employment and household income growth," the IMF said.

Israel pulled troops and settlers out of the Gaza Strip in 2005, but still controls major border crossings and has tightened this cordon to pressure Hamas Islamists to renounce violence. In the long run, the pressure is aimed at ending Hamas's rule over Gaza's 1.5 million Palestinians, most of whom depend on foreign aid.

The IMF said the humanitarian situation in Gaza was "very difficult" as primary crossings allow only imports of basic commodities and are virtually sealed for exports.

Among the stepped up efforts by the Palestinian Authority, to put its finances on sounder footing, the IMF urged comprehensive civil service reform, including changes in the security force to make it more cost effective.

However, the IMF said "it is difficult to envisage these reforms without a solid recovery of private sector growth enabled by relaxation of restrictions on movement and access."

It said the economic squeeze on the poor needed to be eased by better targeting aid transfers.

(Reporting by Lesley Wroughton; editing by Gary Crosse)