RAMALLAH, West Bank, Sept 19 (Reuters) - A gathering crisis in the Palestinian economy will worsen unless foreign funding increases and Israel eases long-standing curbs on development, the World Bank and International Monetary Fund said on Wednesday.

"Looking ahead, with persisting restrictions, financing difficulties with aid shortfalls, and stalemate in the peace process, there is a high risk of a continued economic slowdown, a rise in unemployment, and social upheaval," the IMF said.

In a separate report issued ahead of a conference on Palestinian aid in New York next week, the World Bank forecast a $1.5 billion deficit in the PA budget in 2012, with donor funds expected to cover just $1.14 billion of this shortfall.

"Donors do need to act urgently in the face of a serious fiscal crisis facing the PA (Palestinian Authority) in the short term," Mariam Sherman, the World Bank's country director for the West Bank and Gaza Strip, said in a statement.

The PA, which exercises limited self-rule in the West Bank, receives most of its aid from the United States, the European Union and Arab nations.

But over the past several years there has been a shortfall in aid coming from Arab states resulting in the PA being unable to pay salaries to its 153,000 civil servants on time, on several occasions this year.

A hike in taxes in early September caused by economic accords with Israel that peg Palestinian sales tax to high Israeli rates sparked demonstrations and violence across the West Bank, coupled with calls for the government to resign.

To end the protests, Prime Minister Salam Fayyad last week announced he would roll back the tax increases.


SETTLEMENT BLOCS

Wednesday's reports said the presence of Jewish settlements, which control some 42 percent of West Bank territory, was stifling the potential for Palestinian economic growth.

To build their economy, the World Bank said, the Palestinians need access to "Area C", the territory covering 60 percent of the West Bank where Israel maintains full control under interim peace accords and most settlements are located. Area C includes most of, but not all, the settlements.

"The continuous growth in the size of land that is allocated for settlement activity within the West Bank has fragmented the territory into smaller and more disconnected enclaves," it said.

The United Nations says all West Bank settlements are illegal. Israel disputes this and has sanctioned 120 official settlements since capturing the land in a 1967 Middle East war.

In its report, the IMF saw economic growth in the West Bank and Gaza falling to 6.2 percent this year from 9.9 percent in 2011. It predicted growth of just 5.6 percent in 2013, with unemployment hovering around the 20 percent mark in this period.

Sherman said that even if donor countries met their aid pledges, "sustainable economic growth cannot be achieved without the removal of the barriers preventing private sector development, particularly in Area C".

The World Bank said the PA had made "credible efforts", towards tackling its crisis and building its institutions but Israeli measures "remain the major impediment."

Sherman cited difficulties in obtaining Israeli entry permits to the West Bank for foreign investors, a ban on the import of "dual use" items that Israel fears could be used in weaponry and limits on access to natural resources.

"The most important message of this report is that economic cohesion is not achievable when the areas in which people have to operate and go about their business are crisscrossed by impediments," Sherman said.

The report said Israel has recently shown a willingness to consider the relaxation of specific restrictions in Area C, and had, according to its Foreign Ministry, approved 119 Palestinian infrastructure projects in 2011.

Israel has said it has greatly eased the movement of people and goods in the West Bank, as a result of improved security conditions. It maintains a blockade of the Gaza Strip, whose rulers oppose the existence of the Jewish state.

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