Palestinian government workers fear pay cuts this month after Israel halted transfer of tax revenues in response to a deal to reunite the two rival wings of the Palestinian independence movement.

But many believe the surprise agreement between President Mahmoud Abbas' secular Fatah faction and Hamas Islamists in Gaza will be worth the price if it brings statehood closer.

Israel refuses to deal with Hamas, which does not recognise the Jewish state. The two came close to a second war last month.

On Sunday, Israel blocked the transfer of $105 million in customs duties and other levies it collects on behalf of the Palestinian Authority, which is under the control of Abbas and has been engaged for years in a peace process with Israel.

Israel says it won't let revenues flow to Hamas.

Palestinian officials say that concern is baseless, as any new Palestinian government would be formed by independents. Prime Minister Salam Fayyad says the PA won't be able to pay wages unless Israel releases the April revenues.

The aid-dependent government would have to take out loans to pay its 155,000 workers, Fayyad told reporters on Monday.

Like the majority of government workers, Nidal Arar, a 47-year old government employee, has a mortgage on an apartment in the administrative capital, Ramallah.

"I am very much worried," said the father of three. "I may end up getting half my salary. We will suffer. But I do not mind it if the division is over for good," he said.

"Israel is trying to blackmail us but this won't last long. We have been through this experience before," said Samah Kharouf, a government worker from Nablus.

"If there will be no salaries there will be no Palestinian Authority and this will be in nobody's interest," she added.

Abbas' Fatah movement, once the dominant Palestinian party, was driven out of the Gaza Strip by the Hamas militia in a brief civil war four years ago. Its influence is now confined to the Israeli-occupied West Bank.

STATEHOOD BY SEPTEMBER?

Peace talks with Israel reached a dead-end last September in a dispute over Jewish settlement building in the West Bank. Abbas is now pursuing a plan to declare statehood at the United Nations in September, without Israeli agreement.

Ending the political and geographic split in Palestinian ranks in order to present a united front to the world is central to the credibility of this goal

Prospects of reconciliation were dim during two years of fruitless Egyptian mediation. But recently Palestinians infected by the spirit of the "Arab Spring" began demanding an end to the crippling rivalry. A deal was reached in Cairo last Wednesday.

The Israelis have warned they will not accept what they call a unilateral Palestinian declaration of independence, saying recognition of statehood by a majority of U.N. members can never substitute for a Middle East peace treaty mutually agreed.

Allied to Iran and Syria and shunned by Western governments as a terrorist organisation, Hamas is ideologically at odds with Fayyad and the PA. On Monday, Fayyad welcomed the killing of Osama Bin Laden as a "landmark event". Hamas denounced it as the murder of an Arab "Holy warrior" by U.S. state terrorism.

When Hamas briefly ran the Palestinian government after its surprise election defeat of Fatah in the 2006 parliamentary poll, Western powers imposed an aid embargo to force the group to recognise Israel and accept past peace deals.

As a result, government workers could not get full wages for 17 months, until Abbas appointed the Western-backed economist Fayyad in 2007 and financial aid was resumed.

The PA, which gets most of its operating funds from the European Union, needs $180 million each month for salaries. Fayyad has urged Arab donor countries to pay their overdue financial pledges to make up the budget shortfall.

Banks in the Palestinian territories lent up to $300 million to government employees in the past few years, mainly for homes or cars. Public sector wages are a key driver of the business cycle in the territories, whose economy grew by 9.3 percent growth in 2010.

"We went through hard times in the past but we did not disappear," said Arar. "Let this be the price for unity."