The Israeli-PLO economic agreement worked out during the
negotiations in Paris (1994), referred to as the Paris Economic
Protocol (PEP), did not give the Palestinian Interim Self-Governing
Authority the means of actually governing its own economy. Among
other things, the PEP does not give the Palestinians the right to
issue their currency. The Israeli position as expressed by the
Israeli negotiators can be explained, but not justified, on
political and economic grounds.1
Politically, the Israeli position stemmed from the desire to deny
the Palestinians anything that could be considered "a symbol of
national independence." A national currency is a symbol of an
independent national state. But history tells us that this is not
necessarily the case. Furthermore, it is really paradoxical to
accept one symbol of national independence (namely, the Palestinian
flag) and to refuse some other ones, such as a currency.
The Currency Board System
In British-Mandated Palestine, like in India and many other British
colonies, a currency board system (CBS) was created and
institutionalized by the British and had practically one function:
to issue the local currency under certain rigid rules. The colonial
power did this not as a "symbol" for an independent Palestine, but
for sound economic reasons.
The Palestinian Currency Board (PCB) had no discretionary powers
over the issue of currency since it was required to keep at the
Bank of England a 100% sterling cover against its currency
liabilities which consequently were convertible into sterling at
all times. These sterling reserves were invested on the London
Money Market and accumulated sterling investments served also as a
backing for the Palestinian currency.
The major argument in favor of the CBS, in addition to the
advantage of a sound local currency and full and free
convertibility into sterling at a stable exchange rate, took the
100% reserve requirement as its point of departure. It is often
argued that such a provision has been extremely effective in
preventing governments from resorting to domestic borrowing in
order to finance their expenditures and, hence, has contributed to
the economic stability of countries under the CBS. Currency boards
had neither the discretionary power to increase currency issues,
nor were they allowed to furnish their own governments with loans.
Government borrowing from commercial banks was almost impossible,
not only because any such borrowing would have to be at the expense
of loans to the private sector, but also because of the
underdeveloped nature of the entire banking system. Furthermore,
such borrowing, when it took place, had only limited inflationary
consequences because the increase in the money stock resulting from
larger government expenditures entailed a larger volume of imports
which meant greater outflow, or at least a smaller inflow of
foreign exchange and, thus, a decrease in currency issued.
Faced with such limitations, most governments in British-Mandated
countries, even those which got independence but retained the CBS
(e.g., Jordan until 1964), were forced to adopt balanced budget
policies or to rely on foreign aid to cover any excess expenditure
over domestic revenues. Consequently, most of the territories under
the CBS were saved from a chronic problem of inflation resulting
from budgetary deficits. Inflation or deflation did not originate
domestically; safety and soundness were the hall-marks of the
CBS.
There are, of course, from the viewpoint of the currency-issuing
country, some disadvantages of adopting a CBS. The monetary
authority would be deprived of any authority to issue currency on
discretion, or to control the activities of commercial banks, since
most of these would be in favor of keeping most of their deposits
in foreign assets abroad. The 100% reserve requirement would also
deprive the country of using its reserves abroad in executing
development projects.
So, politically speaking, Israel could have resorted to the CBS
while still militarily occupying the Gaza Strip and the West Bank
(WBGS) without endangering its existence there. More importantly,
Israel should not deal any more with symbols in the case of the
Palestinian problem. Rather, it is the real economy that should
matter now.
When he was foreign minister, Shimon Peres once stated: "We do not
deal with symbols but with the real economy, and a Palestinian
currency is economically superfluous. This obviously raises two
important questions, the answers to which will elucidate the
paradoxical Israeli attitude of accepting certain national symbols
and rejecting others.
Does Israel Deal with the Real Economy of the
Palestinians?
Israel, as mentioned above, did not resort to a CBS in the
Palestinian territories since the beginning of the Israeli
occupation in June 1967. Instead, the Israeli shekel was made legal
tender, beside the Jordanian dinar, in the West Bank. In the Gaza
Strip, only the shekel is legal tender, though the dinar is also
widely used.
Most economists agree that this Israeli policy aimed to facilitate
the process of integration of the Palestinian economy into that of
Israel, not to mention the substantial seigniorage revenue Israel
derives from the circulation of the shekel in the territories.
Hence, by refusing the option of a Palestinian currency, Israel
strove to perpetuate Palestinian economic dependency on the Israeli
economy. There is a clear discrepancy in the Israeli stance: while
Israeli leaders promoted the notion of international aid to rescue
the Palestinian economy, they denied them the right to issue their
own currency on the grounds that a Palestinian currency is
"economically superfluous." Indeed, the argument presented here
suggests that the Israeli policy sought to make the existence of a
viable Palestinian economy superfluous and to perpetuate the past
trends of dependency.
In the past, the Israeli government derived substantial seigniorage
revenue from circulation of the shekel in the Palestinian
territories. In years of hyperinflation, which Israel experienced
in the seventies and the early eighties, this revenue was even
greater due to another source of seigniorage, i.e., the inflation
tax. Around U.S. $809 million worth of Jordanian dinars circulate
in Palestine (about 31.3% of total dinar circulation in Jordan and
Palestine), and around U.S. $977 million worth of Israeli shekels
circulate in Palestine (about 25.4% of total shekel circulation in
Israel and Palestine). According to World Bank estimates, Jordan
would extract seigniorage revenue of about US $50 million per annum
from circulation of the dinar in the West Bank and Gaza Strip
depending on a scenario of a 10% nominal growth rate in the WBGS.
This amount would be roughly 1% of the Jordanian GDP. Estimations
of this source of revenue to Israel are not available. However, and
due to a higher degree of integration between the economies of the
WBGS and Israel, there is every reason to believe that seigniorage
revenue which Israel derives from the West Bank and Gaza Strip
would be not less than 1% of Israel's gross domestic product
(GDP).
Had the Palestinian National Authority (PNA) the right to issue its
own currency, it would have been able to generate about 45.2% of
the GDP of the WBGS (according to statistics from 1991), by
withdrawing the Israeli shekel from circulation in these areas in
return for dollars by which it can finance the purchase of goods
and services necessary to rebuild the infrastructure in the
Palestinian territories. This process alone would allow the PNA to
start implementing public projects of its own and to employ
thousands of unemployed people without waiting for international
aid. The PNA would then be able to levy taxes to generate revenues
to partially cover the government budget. A national currency
issued and controlled by the Palestinian Monetary Authority (PMA)
is the only way out.
Is a Palestinian Currency Superfluous?
The answer, based on the above discussion, is negative. In a
patronizing way, Israeli Finance Ministry officials have been
talking about "saving Palestinians from themselves" and arguing
that "a Palestinian currency would lead to spiraling inflation."
Interestingly enough, in the first years of the State of Israel,
the decision-makers held a rather different view of a national
currency and its role.
Upon its creation in 1948, the State of Israel disposed of no more
resources than the Palestinians do today. Yet, immediately upon the
withdrawal of the last British troops, the Anglo-Palestine Bank in
Tel Aviv was renamed the "Israel National Bank" and authorized by
Ben-Gurion to issue bank notes. In the first four years after the
establishment of the State of Israel, the population doubled
through the waves of immigration; the economy was kept moving
mainly through this new currency, which financed more than half of
the government budget. Yet the inflation rate was lower than it is
in today's Israel. In the first two years of its existence, revenue
from taxes amounted to only a third of the total
expenditures.
According to all international experience, economic development is
subject to the self-supporting economies of agglomeration. In this
process, core regions with the highest economies and technological
potential tend to grow at the expense of the weaker regions which
risk being marginalized. The absence of a Palestinian national
currency would make the income distribution between the countries
of the triangle [Israel/Jordan/Palestine] even worse than it is
now. Such distributional problems do exist within the European
Union (EU) and have been taken into consideration. Certain
political decision-making routines have been established to
maintain such distribution policies within the EU channeled through
the European Regional Fund, the European Social Fund, and the
European Investment Bank. These issues have not been considered in
the PEP.
The fact that the dinar circulates in the Palestinian territories
and Jordan, and the shekel circulates in the Palestinian
territories and Israel, implies that the Palestinian territories
cannot be isolated from price changes in Israel and Jordan.
However, since most imported merchandise of the territories comes
from or through Israel, prices there are highly correlated with the
prices in Israel.
A Monetary Arrangement
The discussion above suggests that a Palestinian currency is
optimal for Palestine. However, monetary management is crucial to a
stable currency, without which a sound economy could not function.
Therefore, two monetary arrangements should be discussed: one for
the short run (up to five years), and the other for the long run
(beyond five years).
A short-run monetary arrangement is the creation of a Palestinian
currency board system (PCB). The Palestinians have established the
Palestinian Monetary Authority (PMA) which, according to the PEP,
is less than a PCB. Renegotiating the PEP to add the function of
issuing a Palestinian currency to those functions of the PMA is a
political and economic necessity. The proposed Palestinian currency
should be explicitly linked to, and backed by, the Jordanian dinar
or any other currency.
The withdrawal of the Israeli shekel will not lead to a fiscal
crisis in Israel. On the contrary, withdrawing the Jordanian dinar
from the West Bank and the Gaza Strip will have a more harmful
fiscal effect on Jordan. To offset the fiscal effects on the
Israeli economy upon the withdrawal of about U.S. $977 million from
circulation, and the immediate request for foreign assets upon
return of the withdrawn notes, could be absorbed by creating a
"currency redemption facility" to help Israel overcome the harmful
effects of such a withdrawal. The IMF and the World Bank should be
able to help the creation of such a facility in case the
Palestinians refuse to buy Israeli goods and services by the gained
foreign exchange.
The historical experience of the CBS suggests that a stable
currency would require a 100% reserve by the back-up currency. The
PMA could maintain such a reserve at the Central Bank of Jordan
(CBJ), for example, and could be able to issue Palestinian notes
equal to those kept by the CBJ. This could be annually enlarged by
an amount equal to the income earned on these reserves at the CBJ.
In such a fashion, monetary expansion would not be
inflationary.
This arrangement is called a pure CBS and it cannot provide the
necessary conditions for the implementation of a discretionary
monetary policy. However, it has some important advantages. First,
if the dinar is stable, the Palestinian currency of the PCB will be
equally stable. Secondly, a PCB can extract at least part of the
seigniorage which otherwise will go to the CBJ. Thirdly, this
arrangement would gain the confidence of the Palestinians in the
PCB's notes and would reduce the possibility of capital
flight.
When this system is established and proves efficient, it would be
made more flexible by allowing the reserve requirement to be less
than 100%. In such a case, the PCB, de facto the PMA, would be able
to extend credit to banks and to issue notes with some discretion,
i.e., the PCB would gradually turn into a monetary authority in the
tradition of central banks. Even though such a flexibility of the
PCB to create money would be limited, it would control inflation
which prevents the need for devaluation and speculative attacks on
the PCB's notes.
This monetary arrangement would allow an exchange rate of 1
Palestinian note to 1 Jordanian dinar, as long as the reserve
requirement is 100%. This would ensure the trust in the new
currency. Jordan's track record of macroeconomic arrangement has
been good. The ability of Jordan to keep this record would add to
the trust in the new currency. One should, however, be aware of the
possibility of precautionary movements out of the dinar into the
dollar. This is evident in the more rapid than anticipated
depletion of reserves in the CBJ since January 1994, a few months
before the creation of the PMA. To ameliorate this problem, the PMA
should permit the Palestinians to keep their savings in dollars in
the operating banks in the Palestinian territories. Another
precautionary measure against an expected increase in the supply of
the PCB's notes because of the "dollarization" could be the sale of
Palestinian bonds, at positive real interest income for the public
by which development projects could be partially financed.
In the long run, the PCB suggested here could move into a full
sovereign monetary arrangement. Though this movement may depend on
political circumstances, economic conditions in the region and the
world would entail an appropriate arrangement. It is the
responsibility of the PMA to be flexible enough to frequently
identify and assess the situation. In any case, the PMA must try to
be independent and not fall into the temptation of printing money
to finance the PNA budget, for such a trap is simply inflationary.
The motto of the PMA must always be "evolution rather than
revolution."
1. Shortly after he was voted into office, Prime Minister
Ehud Barak stated in a press conference that the Palestinians
should have their own currency. However, this declaration has not
had any official follow-up to date, nor has it led to a
renegotiation of the economic agreement between Israel and the
Palestinians.
