The World Bank warned donors on Sunday that the financial crisis gripping the Palestinian Authority since Hamas won election was deeper than it first thought and could render the West Bank and Gaza ungovernable.
In a memo circulated among major donors and obtained by Reuters, the World Bank also said an existing aid program could be expanded to pay for the salaries of employees of the Hamas-led government.
In March, the World Bank projected that by the end of 2006 Palestinian poverty and unemployment levels would rise to 67 and 40 percent, and personal incomes would drop by 30 percent.
"We now consider these figures underestimates," it said in the memo.
Western diplomats said the World Bank circulated the memo ahead of a meeting in New York on Tuesday of the Quartet of Middle East negotiators - the United States, the European Union, Russia and the United Nations.
Western powers led by the United States and the European Union have frozen direct aid to the Palestinian Authority to put pressure on Hamas to renounce violence, recognize Israel and abide by interim peace deals.
Local, regional and international banks, fearful of being hit with U.S. anti-terrorism sanctions and lawsuits, have refused to deal with the Authority.
As a result, the Hamas-led government has been unable to pay salaries to 165,000 public employees since March, prompting concerns of a humanitarian crisis that could trigger an upsurge in Middle East violence.
"A continuation of this crisis threatens to undermine Palestinian institutions and cause severe damage to structures that donors have been building since 1993," the World Bank said.
"The institutional decay will likely also have a negative impact on security, which in turn would make it difficult for government, the private sector and providers of humanitarian assistance to operate properly.
"The ensuing institutional damage may be irreversible and could lead to a situation in which West Bank and Gaza in effect becomes ungovernable," the World Bank said.
To ease the crisis while bypassing the Hamas-led government, European powers Britain and France have backed the creation of a special trust fund to help pay salaries to at least health and education workers.
But Western diplomats say the United States has been trying to block the proposal on the grounds that paying salaries would take pressure off Hamas.
In its memo, the World Bank said an existing program, known as the Emergency Services Support Project (ESSP), has for the last five years provided support to the Palestinian ministries of education, health and social affairs.
According to the memo, the Hamas-led Palestinian Authority "itself has said that it has no objection in principle to a temporary bypassing of its fiduciary mechanisms".
The World Bank said donor assistance dropped "more precipitously than expected", Israel further tightened Gaza and West Bank restrictions, and financial transactions by Palestinian banks have been sharply curtailed.
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