By Wafa Amr

RAMALLAH, West Bank, Feb 28 (Reuters) - Salam Fayyad, who won international acclaim for reforming Palestinian finances under Yasser Arafat, now faces a similar challenge as he returns to the job of finance minister, in a Hamas-led unity government.

A U.S.-educated moderate who favours peace talks with Israel, Fayyad raised eyebrows abroad when he accepted the key cabinet post after Islamist Hamas signed a power-sharing deal with the rival Fatah faction this month. For him, it was mainly a question of helping to patch up Palestinian unity after months of infighting. Hamas, for its part, hopes the former World Bank official will also find a way of lifting a crippling Western aid embargo on the Palestinians.

"I believe we must try to do the best we can to deal with this problem. As we do this, we should continue to engage in opening up all possibilities for financing," Fayyad, 54, told Reuters in an interview.

"The task is sure to be complicated," he said.

Fayyad is no stranger to the international isolation of the Palestinian Authority, having served as finance minister for Arafat after the late president was shunned by the United States over Palestinian-Israeli fighting that erupted in 2000.

Then, the aid-dependent Palestinian Authority was plagued by mismanagement and graft. Hamas, by contrast, has a corruption-free reputation but is classified as a terrorist organisation in the West for its history of attacks on Israel.

Western powers have suspended aid to the Palestinian Authority because of Hamas's refusal to renounce violence and recognise the Jewish state. Israel has also withheld hundreds of millions of dollars in taxes levied on the Palestinians' behalf.

For Fayyad, who first served as finance minister between 2002 and 2005, it is familiar ground.

"Then there also was a siege. Money that was collected by Israel at the time I took office was withheld for 20 months, and a lot of reform was required," he said.

REFORMS REVERSED

One of Fayyad's first moves in 2002 was to ensure that all revenues flowed into a Finance Ministry-controlled account. That prevented funds being used at the discretion of individual officials. He also scored points for breaking up monopolies.

But since Hamas took power last March, triggering the aid embargo, Fayyad's reforms have been reversed, he said.

"Now there's a multiplicity of spending centres. Not all revenues come to a single treasury account as should be the case in a system of public finance with integrity. All of that has to be addressed, in addition to coming up with adequate funding," he said.

A major concern for Fayyad is that U.S. laws penalising financial dealings with the Hamas-led government have made local, regional and international banks unwilling to transfer funds directly to the Palestinian Authority.

"A key challenge now, which did not exist in 2002, is dealing with the banking restrictions. The intensification of the siege over the period of the past year played a key role in the P.A.'s institutional degradation," Fayyad said.

The Hamas-Fatah pact, which had a vague pledge to "respect" past peace deals with Israel, helped calm factional tensions but has yet to change the Authority's treatment by the West, which has said it will judge the new government by its actions.

That means that Fayyad, though favoured by the Bush administration, may be shunned by the United States and Israel.

Palestine Monetary Authority chief George Abed said Fayyad might manage to circumvent the embargo by using his second title -- head of the umbrella Palestine Liberation Organisation's Economic Affairs Department -- for financial dealings abroad.

Asked why he was willing to take on such an onerous task, Fayyad said: "I'm a Palestinian. I grew up here. I have a sense of mission and duty. Lifting the siege is a priority, but preventing a civil war is a higher priority."

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