By Adam Entous

JERUSALEM, June 8 (Reuters) - The European Union and other Western donors are considering expanded aid programmes to ease financial pressure on the Hamas-led Palestinian Authority, struggling under sanctions, Western diplomats said on Friday.

The EU already provides direct support to the Authority's workers outside of security forces, paying allowances through a mechanism that bypasses the Hamas-led unity government.

One proposal under EU consideration calls for expanding the existing Temporary International Mechanism (TIM) to pay a portion of the Palestinian Authority's arrears to private Palestinian contractors, diplomats said.

"If it's decided, it would start at a low level. But if there is sufficient availability of funds, it could be expanded," an EU official involved in the process said.

Another European diplomat said the initial EU contribution through the TIM was likely to be only 10-15 million euros ($13-20 million), but it could grow over time as more donors contribute funds.

Palestinian Finance Minister Salam Fayyad has already begun talks with other Western donors and the World Bank about the possibility of restoring budget support needed to keep the Palestinian Authority and its ministries running longer-term.

Western donors led by the United States cut off direct financial aid to the Palestinian Authority in March 2006 after Hamas defeated President Mahmoud Abbas's secular Fatah faction in parliamentary elections.

Coupled with Israel's withholding of tax revenues that it collects on the Palestinians' behalf -- the Authority's main domestic source of funding -- the sanctions have pushed the Hamas-led government to the brink of financial collapse.

"There are no attractive alternatives. If we allow this government to crumble, the implications for the institutions of the Palestinian Authority are very grave and radical splinter groups may come out strengthened as a result," EU External Relations Commissioner Benita Ferrero-Waldner said this week.

ARREARS

One Palestinian official said the EU would soon pay "millions of dollars" to cover Palestinian Authority payment arrears, a move that would be equivalent to a cash injection but would need no direct transfers to the Palestinian government.

"We have told the Europeans ... that the EU must review its previous payment policy and expand it in order to avoid the collapse of the Palestinian Authority," the official said.

Advocates see the financial moves as part of a broader shift in strategy that could address Arab calls for the United States and the EU to ease sanctions before trying to jumpstart peace talks between Israel and the Palestinians and Arab League.

Some Israeli officials decry what they see as a policy shift, endorsed by the United States, that will reduce pressure on Hamas to formally recognise Israel, renounce violence and abide by previous interim peace deals with the Jewish state.

The Bush administration gave a green light last month to donors to channel funds through a Palestine Liberation Organisation account controlled by finance minister Fayyad.

Fayyad has started making partial salary payments to state employees and security personnel through the PLO account. He wants the World Bank to administer a new budget support programme on behalf of donors.

"This will be discussed in the coming months but is unlikely to be in place before January 2008," a Western diplomat involved in the matter said.

Israel has also signalled a willingness to transfer withheld tax revenues to the Palestinians, although far less than the $700 million sought by Abbas.

Israeli officials estimate that only $300 million to $400 million could be transferred to the Palestinians because the rest of the money has been frozen by court orders.

Abbas on Wednesday called off a summit with Israeli Prime Minister Ehud Olmert, seeking commitments Israel will release frozen Palestinian funds and take other steps.

EU officials have insisted that despite its formation of a unity government with Fatah in March they will not help Hamas until it clearly renounces violence and recognises Israel.

Some Palestinian officials argue that Hamas is already de facto engaging with Israel, however. Outgoing British Prime Minister Tony Blair said in remarks broadcast on Friday: "Some of the signs coming out of Hamas are not unhelpful."

(Additional reporting by Mohammed Assadi in Ramallah and Mark John in Brussels)

AlertNet news is provided by