RAMALLAH, West Bank, March 8 (Reuters) - The Western-backed Palestinian Authority said on Monday its recurrent budget deficit will fall to 16 percent of gross domestic product (GDP) this year from 22 percent in 2009.

Prime Minister Salam Fayyad's government, which relies on international aid to meet its needs, forecasts its 2010 recurrent deficit falling to $1.21 billion from $1.45 billion in 2009.

"This would be the lowest deficit as a share of GDP since the year 2000, and a major step forward towards enhancing financial sustainability," the authority said in a statement.

The total fiscal deficit, projected at $1.88 billion, is expected to be financed by donors, it said.

The Palestinian Authority's revenues are projected to increase by 20 percent this year, "exceeding $2 billion for the first time, on the strength of administrative reform in tax collection and robust economy growth projections".

Policymakers expect the Palestinian economy in the West Bank to match the 7 percent growth estimated for 2009, while the economy of the Gaza Strip, ruled by the Hamas group, continues to shrink due to a tight blockade enforced by Israel and Egypt.

Fayyad expected a 10 percent growth if the blockade on Gaza was lifted.

Hamas is hostile to Israel and disputes the legitimacy of Fayyad's Ramallah-based cabinet. Fayyad's government still pays salaries to government employees in the Gaza Strip.

Fayyad -- whose budget forecasts current expenditure at $3.13 billion, about half of it allocated to the Gaza Strip -- has set a goal of developing the institutions of a Palestinian state by mid-2011. The budget allocates $667 million to development "in line with our strategy of generating development from the ground up", the official statement said.

In 2009, Fayyad had spent some $400 million worth of 1,000 infrastructure projects in the occupied West Bank and plans to pay $350 million out of the $667 million allocated for development in 2010, for another 1,000 "micro projects".

Fayyad said the ultimate goal of his fiscal policy was to minimise dependency on foreign aid while refocusing on increasing income-generating projects in the Palestinian territories as part of his state-building efforts.

He said the end game of such policies was meant to "strengthen the capability of the Palestinian Authority, and later on the state of Palestine," Fayyad told a news conference.

He said he hoped "to create enough facts on the ground that go in line with the concept of the independent state of Palestine in all fields of infrastructure, services and capabilities," Fayyad added.

(Additional reporting by Ali Sawafta; Writing by Tom Perry; editing by Patrick Graham)