Unity Government Faces An Uphill Task

BMI View: The Palestinian unity government formed on June 2, which reunites Fatah and Hamas in a single political authority for the first time since 2007, will struggle to improve the Palestinian territories' stagnant economic outlook. The mutual tensions between the two parties are set to intensify in the run-up to presidential elections scheduled for 2015.

The formation of a Palestinian unity government on June 2 marks a symbolic end to the long-running dispute between the rival Fatah and Hamas factions ruling the West Bank and Gaza Strip respectively. The new government will bring together the two Palestinian territories under a single political authority for the first time since 2007, and paves the way for presidential and parliamentary elections scheduled to take place in 2015. Announcing the unity agreement, Palestinian President Mahmoud Abbas declared "the end of division that caused catastrophic harm to our cause".

Yet the deal will do little to improve the Palestinian territories' stagnant economic outlook, with economic activity set to remain undermined by financing constraints and continuing Israeli restrictions on trade and movement. Moreover, maintaining a central government over two geographically separate regions will be a massive challenge, and we are cautious over the sustainability of the reconciliation agreement. We expect several issues to flare up over the coming months, including the question of succession to Abbas; integration of the dual administrations run by Fatah and Hamas; and managing the fallout in relations with Israel.

Unity Challenged By Geographic Separation
Palestinian Territories - Map

BMI View: The Palestinian unity government formed on June 2, which reunites Fatah and Hamas in a single political authority for the first time since 2007, will struggle to improve the Palestinian territories' stagnant economic outlook. The mutual tensions between the two parties are set to intensify in the run-up to presidential elections scheduled for 2015.

The formation of a Palestinian unity government on June 2 marks a symbolic end to the long-running dispute between the rival Fatah and Hamas factions ruling the West Bank and Gaza Strip respectively. The new government will bring together the two Palestinian territories under a single political authority for the first time since 2007, and paves the way for presidential and parliamentary elections scheduled to take place in 2015. Announcing the unity agreement, Palestinian President Mahmoud Abbas declared "the end of division that caused catastrophic harm to our cause".

Yet the deal will do little to improve the Palestinian territories' stagnant economic outlook, with economic activity set to remain undermined by financing constraints and continuing Israeli restrictions on trade and movement. Moreover, maintaining a central government over two geographically separate regions will be a massive challenge, and we are cautious over the sustainability of the reconciliation agreement. We expect several issues to flare up over the coming months, including the question of succession to Abbas; integration of the dual administrations run by Fatah and Hamas; and managing the fallout in relations with Israel.

Unity Challenged By Geographic Separation
Palestinian Territories - Map

Unity Deal Brought About By Necessity...

The impetus for reconciliation between Fatah and Hamas largely came from the weakness of both sides. We had noted in March 2013 that the likelihood of a breakthrough had improved, owing to a changed balance of power between the two parties and increased domestic pressures for a deal (see 'Mixed Prospects For Reconciliation Agreement', March 4, 2013). The failure of peace talks between Israel and the Palestinians to progress - an outcome we had anticipated - added further momentum. The peace negotiations were formally ended by Israel on April 24 following the announcement of the Palestinian unity agreement, but had already been faltering in the preceding months.

The composition of the unity government reflects Hamas' recent wounds. The Islamist movement has been damaged by a nearly year-long blockade of the Gaza Strip by the Egyptian military, which has forced it to delay wage payments to civil servants and halted construction activity. Out of 17 cabinet members, only five come from Gaza. Rami Hamdallah, who held the position of prime minister of the West Bank government from June 2013 onward, will head a largely technocratic cabinet. Abbas has pledged that the unity government will meet international conditions for diplomatic contact, including recognition of Israel, adherence to previous agreements, and renunciation of violence. All three of these terms had previously been anathema to Hamas.

We regard Hamas' low-key presence in the government as positive for the Palestinian territories' political outlook. Major donor countries, including the EU, China and India, have issued statements of support for the unity deal. More unexpectedly, the US administration has also announced that it will work with the new government, bucking criticism from Israel and senior US lawmakers. The Israeli government warned in April that it would impose sanctions and suspend the transfer of customs duties collected on goods headed to the Palestinian territories, which account for two-thirds of the Palestinian budget. Yet Israel has not yet followed through on its threats, and might be loath to act without international support.

... But New Government Faces Numerous Challenges

Having retained most of its sources of funding, the Palestinian government will be able to avoid a fiscal crisis for the time being. Yet barring an increase in donor aid, the authorities will have few means to address the West Bank and Gaza's precarious economic outlook. The prospects for an Israeli-Palestinian peace deal have collapsed, burying with them the 'Kerry Plan', which envisaged USD4bn in private sector investments for the territories if the talks succeeded. In the event that donors or Israel do scale back their support, renewed financing constraints would result in delayed payments to the public and private sectors, pressure on domestic banks, and a significant increase in political risk.

Set To Grow Below Historical Levels
West Bank and Gaza - Real GDP Growth, %

Moreover, the government will struggle to integrate the disparate administrations and security forces of the West Bank and Gaza as a single entity. Maintaining cohesion between two territories with discontinuous borders will be difficult, as Israel has already barred Gazan ministers from travelling to Abbas' West Bank headquarters. Administrative efficiency gains will be limited; Hamas will likely oppose any cuts to the 40,000 civil servants who had been working for its government in Gaza. Scuffles broke up between Fatah and Hamas civil servants in Gaza on June 5, when only the former received their salaries.

Hamas will also retain its extensive security presence in the Strip, albeit placing them nominally under the direction of a new Interior Minister. The group controls 20,000 armed personnel in addition to the 25,000-member Qassam Brigades, among a total Gazan population of 1.66mn.

Over the longer term, Hamas could benefit from its limited presence in the unity government. As we have noted, the movement has been weakened by its exposure to power, which has forced it to shoulder the responsibility for Gaza's economic stagnation (see 'Hamas Weakened, But Likely To Survive', November 27, 2013). Hamas will now be left free to concentrate on its military capabilities and rebuild its popularity on the ground. By contrast, the boost in domestic support obtained by Abbas as a result of the unity deal will fade rapidly if he proves unable to improve economic conditions in the territories.

Elections To Spark Tensions

We expect the mutual suspicions between Fatah and Hamas to come to the fore in the run-up to the next Palestinian presidential elections, to be held in 2015. Abbas' presidential term expired in 2010, but new elections were repeatedly delayed by the tensions between the two parties. Polls taken before the announcement of the unity deal suggest that Marwan Barghouti, a prominent Fatah figure, would be the Palestinians' favoured candidate, beating Abbas by seven percentage points (see chart below). His credentials mean that he could receive the support of Hamas, and have the political capital necessary to negotiate a settlement with Israel.

Would Israel Release Barghouti?
West Bank and Gaza - Presidential Opinion Poll

However, Barghouti is serving five life terms in an Israeli prison for involvement in five murders during the second intifada (2000-2005); it is doubtful that Israel would release him if he does become elected. His victory could therefore lead to a Palestinian leadership vacuum. Alternatively, Abbas could remain President, riding on the back of the popularity gains obtained as a result of the unity deal. Such an outcome would be preferred by international donors and the US, who regard the 79-year old Abbas as a moderate figure - but would likely encounter opposition from Hamas.

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Sector: Country Risk
Geography: West Bank and Gaza
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