(Reuters) - Palestinian dreams of building a strong economy to speed up the state's drive towards independence could soon be plunged into darkness, quite literally.

The cash-strapped government of the occupied West Bank, the Palestinian Authority (PA), is so behind with its bills that the Israeli company that provides Palestinians' electricity has threatened to cut the power unless the PA pays outstanding debt of almost $80 million.

Poor planning and continued, rigid Israeli controls have caused boom time Palestinian growth rates of 9 percent in 2010 to fall by half, and struggling businesses are accusing the PA of not helping them as they face ruin.

Hopes, entertained by Israeli and Palestinian leaders alike, that the U.S.-backed Palestinian Authority could build a viable economy before statehood are fading fast.

"There is no illusion whatsoever that we can achieve our full potential given the restrictions under which we have to operate," Palestinian Finance Minister Nabil Kassis told Reuters.

Two decades after the Oslo interim peace accords, there is still no final treaty and the lack of progress has caused a sharp drop in foreign aid. United Nations agencies and Palestinian economists say the economic annexes of the Oslo pact, outlined in the Paris Protocol of 1994, have been implemented by Israel selectively and mostly to its benefit.

The government is grappling with a recurring deficit and external debt, both hovering above a billion dollars or nearly a fifth of gross domestic product. Some economists say economic growth could be as low as 3-4 percent this year, and with a fifth of the population unemployed, prospects for many of the West Bank's 2.5 million Palestinians are declining.

Bassim Khoury, head of Palestinian generic drug maker Pharmacare PLC, says he is doing his best to build a major West Bank business, but complains that the odds are against him.

Israel limits the import of basic raw materials such as glycerin, a common solvent deemed by Israel to be a "dual purpose" substance that could be used in bomb making, and exports are frequently turned away at Israeli checkpoints.

"It's like jumping on a trampoline; you don't realize how high you can go until you smack your head on the glass ceiling that's been put above you," Khoury said, pointing with a sigh to the tantalizing potential of Brazil and East Asia.

He heaps criticism on the PA, denouncing its failure to pay suppliers to hospitals of such basic drugs as insulin, while the security services, which account for around a third of the budget, always get paid.

"The (Palestinian) leadership is simply not competent enough to level the playing field. With this occupation, we have no future as an economy," he said.

The PA has worked in recent years to encourage the growth of the service sector, reduce corruption and build civic institutions. But attempts to broaden its revenue base by raising taxes had to be cut back amid a popular backlash.

Struggling to keep the economy afloat, the finance ministry this week took out a further $75 million loan from domestic banks to address unpaid debts to construction and service sectors which total six times that amount.

At the Jalazoun camp for refugees from the 1948 war for Israel's independence and their descendants, located near the territory's makeshift capital Ramallah, electricity bills have not been paid for more than a year due to the government's financial problems.

The PA stopped paying for electricity at Jalazoun and other camps and villages around the time an aborted bid for statehood recognition at the United Nations last year incurred sharp cuts in aid from the United States and the withholding of customs revenues collected on the Palestinians' behalf by Israel.

As the electricity crisis has grown, officials have hinted recently that they might force camp dwellers to pay the bills. However, even if they did, interim peace agreements with Israel bar Palestinian authorities from policing many refugee camps and rural areas and extracting unpaid arrears.

"We've alerted the PA for years that we could come to the position we've arrived at today, and we need a solution fast," said Hisham al-Omari, head of the Jerusalem Electric Company, a Palestinian company that distributes electricity in the territory, which is provided by the private Israel Electric Corporation.

PA officials say they don't have the money to cover the cost, but the crisis has pushed the Jerusalem Electric Company, the Palestinians' largest electricity distributor, to the brink as the Israeli provider has threatened to take it to court and have its assets seized.

OPTIONS IN SHORT SUPPLY

Israeli Prime Minister Benjamin Netanyahu took some credit for the boom in the Palestinian economy thanks to his decision to cut back on army checkpoints around the kidney-shaped West Bank, improving the flow of goods and people.

But economists contend that the fast growth was mostly fueled by reconstruction following the Palestinian uprising in the first half of the last decade, coupled with a surge of foreign aid in the expectation of a breakthrough in peace talks.

Foreign aid is now lagging, as a hoped-for $1.1 billion in 2011 reached only $750 million, as pledges from Gulf states in particular fell short. The construction sector, key to the economic boom of recent years, now contributes a third less to Palestinian GDP than it did when the Oslo accords were inked in 1994.

The Paris Protocol of 1994 maps out an economic blueprint for a customs union between Israel and the Palestinian territories and pegs value-added tax to Israeli rates, now at 17 percent. However, provisions allowing the Palestinians to make free-trade agreements with other states and mandating access to Israeli markets have not transpired.

Perhaps worried that the stalling economy will unleash unrest in the territories, Israel is showing flexibility.

After a year of negotiation, Israel agreed this summer to streamline the handling of import duties it collects on goods bound for the Palestinian market - duties worth some $100 million a month, around two-thirds of PA income.

A new system of electronic vouchers and stricter oversight of goods coming in and how they should be taxed may reduce tax evasion and yield more cash for the salaries and contracts that the PA is struggling to pay.

Israel has serially withheld the payments import duties as punishment for past Palestinian political maneuvers, such as negotiations with Islamist rivals in Gaza or U.N. statehood initiatives - a tactic it would almost certainly reintroduce should the PA revamp its U.N. recognition bid this year as it has pledged.

SIMMERING PROTESTS

Israel's attempt a few months ago to secure a $1 billion International Monetary Fund loan on the Palestinians' behalf - which failed as the IMF reportedly declined to disburse a loan for a non-state entity - and an advance payment of customs duties before the Muslim holiday of Ramadan, showed rare goodwill in an otherwise fraught relationship.

"We are given hopeful signals from time to time," said Finance Minister Kassis, though he saw the move as only a partial fulfillment of the Paris Protocol.

"As far as reopening the Paris Protocol, it's an annex of a larger agreement, and it's difficult to do when no negotiations are taking place," Kassis said.

Negotiations between Israel and the Palestinians ground to a halt in 2010 in a row over continued Jewish settlement building in the West Bank. The talks remain blocked, as do domestic moves to stimulate the economy, causing aggravation in the streets.

Scores of young men in the southern West Bank city of Hebron gathered to protest a recently announced fuel price hike of around 5 percent, burning an effigy of Prime Minister Salam Fayyad, who helped preside over economic policy as finance minister until being replaced earlier this year.

Picketing Fayyad's office on Sunday, dozens of sandaled lorry drivers protested against the price hike - which automatically tracks one in Israel, per the Protocol - that threatens their livelihoods.

"They do nothing to keep us safe, to keep our children fed and in school, to give us the means to live our lives in dignity," said Mahmoud al-Tarifi, the owner of a trucking company leading the protest.

Pointing to the glassy modern buildings of the Ramallah government quarter, trucker Ahmed Mahmoud said, "This is built on our dime, on our backs, while we're left with nothing."