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A much anticipated meeting of donor countries that could have freed $160 million in aid to the Palestinians was canceled Friday after negotiators for the Palestine Liberation Organization and Israel argued over the status of Jerusalem.

Announcing the cancellation, the World Bank, which had organized the meeting, expressed "deep disappointment at the way things have evolved." The donor countries were ready to disburse some of the $2.4 billion they had pledged to Palestinians for projects in the Gaza Strip and Jericho over the next five years.Israel rejected proposals by the PLO to finance institutions in mainly Arab East Jerusalem, which the Palestinians have vowed to make their capital; Israel has always maintained that Jerusalem will remain united as its capital.

Israeli officials argued that financing institutions in East Jerusalem would circumvent an accord reached last year by the PLO and Israel to negotiate the final status of the city only after self-rule had been introduced over three years.

In a news conference at the World Bank headquarters in Paris, Nabil Shaath, the chief Palestinian negotiator, said the PLO had assigned only $4 million of the anticipated $160 million in aid to East Jerusalem, largely to maintain Palestinian social services.

World Bank officials and representatives of many of the donor countries were baffled by the debacle.