The Palestinian Authority has held informal talks with the World Bank to discuss ways to ease its budget problems, but the bank has criticised what it calls uncontained government spending.

A bank official said on Wednesday: "There have been some discussions with the caretaker government in Ramallah, but there has been no formal request from the Palestinian Authority."

After Hamas won the parliamentary election last week the United States and the EU threatened to cut off funding to the authority unless Hamas renounced violence and recognised Israel, increasing fears that the financial situation will worsen.

Israel halted a $55 million tax payment due to the Palestinian Authority on Wednesday because of the Hamas victory.

In an updated report released on Wednesday, the World Bank said the Palestinian Authority's fiscal position had become increasingly unsustainable because of "uncontained" government spending, including sharp increases in salaries and hiring staff.

Reform wrangle

The World Bank has managed a multidonor reform fund for the Palestinian Authority since 2004 and withheld a payment of $60 million in December because a series of reforms agreed with the Palestinians had not been completed.

However, the official said that if all 12 donors that contribute to the reform fund agreed, the money could be disbursed to the authority by waiving requirements for reforms.

A total of $310 million has been committed to the Public Financial Management Reform Trust Fund by the donors, of which $250 million had been disbursed in four installments by the middle of last year. The biggest contributors are the European Commission, Japan, Norway and Britain.

"The significant increase in public-sector salaries and public hiring is a setback with respect to the efforts of placing the PA on an orderly fiscal footing," the bank said.

"The PA has not committed to any mitigating measures to bring the fiscal situation under control."

Solid growth

In 2005, the Palestinian Authority's budget deficit reached about $800 million, of which $340 million was financed by donors in the form of direct budget support.

"Unless addressed promptly, deficits of this magnitude will compromise the proposals of rapid recovery by destabilising the Palestinian Authority's operations and by reducing the public and private resources otherwise available for productive investment," the World Bank said.

The bank's report estimated that economic growth in the West Bank and Gaza reached a solid 8% to 9% last year in the wake of a gradual economic recovery that began in 2003.

The Palestinian economy has withered since the start of an uprising against Israel in 2000, hampered by violence as well as mismanagement and corruption that have discouraged donors.

The bank said the Palestinian economy still operated well below its potential and unemployment remained high especially among youths.

Two Palestinians have been killed in a shootout with Israeli soldiers in the northern West Bank.

Aljazeera's correspondent quoted the Islamic Jihad as announcing the death of two of its activists, including a leader of al-Quds Brigades in the West Bank, Nidal Abu Saada, in a military operation launched by Israeli soldiers on Tuesday in Araba village, south of Jenin.

Four other Palestinians were injured during clashes after 20 Israeli military vehicles stormed into the village and laid siege to a building.

An Israeli army spokeswoman said that Tuesday's incident in which the two Palestinian fighters were killed also caused an unknown number of Israeli casualties.

Israeli border police entered the village to arrest suspects from the Islamic Jihad organisation, which has been responsible for the last six bombings in Israel, an Israeli army spokeswoman said.

Israeli casualties

"An exchange of fire erupted between two Islamic Jihad terrorists and the border police force in which these two Islamic Jihad terrorists were killed. There were also casualties on our side," she said.

She refused to provide any further details on the Israeli casualties.

Also on Tuesday, Aljazeera said, Israeli occupation forces arrested 22 Palestinians in various parts of the West Bank.

The campaign of arrests focused on Bani Zaid village and Jalzun camp in the Ram Allah governorate. It covered as well a number of villages south of Qalqilia and west of Bethlehem.

Activists held

Most of the arrested Palestinians were activists of Hamas, Fatah, Islamic Jihad and the Popular Front for the Liberation of Palestine, Aljazeera's correspondent said.

Palestinian witnesses said an Israeli soldier was also wounded in the shootout and evacuated by helicopter to an Israeli hospital.

Later in the day, al-Quds Brigades said it fired two missiles at the Israeli Negev township of Sderot, north of Gaza Strip, and described the operation as its initial response to the Israeli operation.

Hamas has appealed to the European Union not to cut aid to a Palestinian government that might include the Islamic militant group.

Ismail Haniya, a Hamas leader, said in Gaza on Monday: "We call on you to understand the priorities of our Palestinian people at this stage and continue the spiritual and financial support in order to push the region towards stability rather than pressure and tension."

Haniya, who headed Hamas's list of candidates, also appealed to the so-called Quartet of Middle East peace negotiators - the United States, the EU, the United Nations and Russia - to talk to the Islamic group without preconditions.

Pressure

In Israel on Sunday, Angela Merkel, the German chancellor, said there was no way the European Union could provide direct financial support for a Palestinian government that included Hamas as long as the group refused to give up violence and acknowledge Israel's right to exist.

Hamas, which has carried out nearly 60 suicide bombings in Israel since a Palestinian uprising began in 2000, swept to victory over the long-dominant Fatah faction of Mahmoud Abbas, the Palestinian president, in a parliamentary election on Wednesday.

Last year, the EU gave the Palestinian Authority $615 million, money vital for its survival.

Before a meeting in London on Monday, Condoleezza Rice, the US secretary of state, said she believed that the United Nations, the EU, Russia and other powers involved in the Middle East were "on the same page", that funding must not go to Hamas and other groups that advocated destroying Israel.

Israel has decided to freeze funds to the Palestinian Authority in case the money could end up aiding terrorist elements.

The decision was announced by Ehud Olmert, the acting prime minister of Israel, on Monday.

"It must be made very clear, we are not going to transfer funds which could finance terrorist attacks against our civilians," Olmert said on public radio.

Israel was due to hand over $35 million to the Palestinian Authority on Wednesday.

It decided to cancel the transfer after the stunning victory by Hamas, the Islamist resistance group, in Palestinian legislative elections last week.

Hamas, responsible for most of the anti-Israeli suicide attacks during the current Palestinian intifada, or uprising, has refused to disarm and espoused the destruction of Israel as part of its charter.

The blocked funds essentially correspond to sales tax revenues and customs duties levied on imported products coming into the Palestinian territories and crossing Israel.