* Gaza feels bite of Egypt's crackdown on smuggling tunnels
* Hamas and Egypt's government at loggerheads
By Nidal al-Mughrabi
GAZA, Oct 9 (Reuters) - Hamas is struggling to meet its payroll in the Gaza Strip, where income from taxes has been badly hit since neighbouring Egypt started destroying a network of tunnels used to smuggle food, fuel and weapons into the Islamist-run enclave.
The crisis means that Gaza's thousands of civil servants may not receive their full salaries in time for an important Muslim holiday next week.
Egypt, which accuses Hamas of aiding Muslim militants in the lawless Sinai desert, has been waging a campaign to destroy the smuggling tunnels that delivered weapons and other goods to the Gaza Strip, which is partially blockaded by Israel.
Hamas, which denies the Egyptian allegations, taxes the traffic through the tunnels - a money stream that has now virtually run dry.
Last month, the Hamas government paid only 77 percent of its $25 million August payroll for Gaza's 50,000 civil servants.
It said on Tuesday it would make a special payment of 1,000 shekels ($280) to the employees on Thursday before the Eid al-Adha holiday. There is still no word on whether full September salaries will be paid this month.
"What is supposed to be a day of joy and happiness would turn into a nightmare, a disaster, because we cannot afford to feel happy," said 47-year-old public servant Mohammed Khalil.
During Eid al-Adha, Muslims traditionally slaughter sheep or cattle and share the meat with the poor. Many parents buy new clothes for their children.
Khalil, a father of six, told Reuters he received most of his 1,700 shekel salary for August, but it was not enough to enable him to pay his electricity or water bills.
UNEASY RELATIONSHIP
Hamas, an offshoot of the Muslim Brotherhood, has governed Gaza since 2007 and has an uneasy relationship with Egypt's new army-backed leadership, which toppled the elected Islamist president, Mohamed Mursi, a Hamas ally, in July.
It is unclear exactly how much money Hamas used to take in from tunnel traffic. Economists in the Gaza Strip said the income covered 70 percent of the government's monthly budget. Hamas officials put the figure at 40 percent.
Some 1 million litres of petrol used to reach Gaza daily through the tunnels from Egypt. Hamas collected 1.60 shekels per litre. Cement once came through at a rate of 3,000 tonnes a day. Hamas's cut was 20 shekels per tonne, according to tunnel operators and local economists.
Ala al-Rafati, the Hamas-appointed minister of the economy, said up to 90 percent of the tunnels had now been destroyed by the Egyptian army and those still open were not operating fully. He put the losses to the Gaza economy since June at $460 million.
He added that the Gaza government's annual budget was more than $700 million, with $260 million devoted to running costs.
Hamas has also been hit by a downturn in its relations with its main backer, Iran, which used to provide it with arms and funds estimated by diplomats to total some $250 million a year.
Relations became strained after Hamas turned against Tehran's ally, President Bashar al-Assad, in Syria's civil war, and Iran's financial largesse has shrivelled, diplomats believe.
Hamas, which is shunned by the West over its refusal to renounce violence and recognise Israel's right to exist, weathered an economic crisis in 2007 when the group seized control of the Gaza Strip from forces loyal to Western-backed Palestinian President Mahmoud Abbas.
Israel tightened its blockade at the time, but the tunnel business flourished, enabling Hamas to fill its coffers.
Since 2010, Israel has eased internationally criticised economic restrictions on the territory and recently allowed the entry of cement and steel for private construction for the first time since 2007. Palestinians said it was not enough to meet the needs of the Gaza Strip's 1.8 million people.
NO TAXES
Cairo's closure of the tunnels over the last three months has caused prices to spike and production to drop at factories dependent on raw materials from Egypt.
Gaza economist Maher al-Tabaa' said that for Hamas, this translated into "no taxes on smuggled goods and may soon mean no taxes on locally manufactured products".
Abdel-Salam Seyam, secretary general of the Hamas government, acknowledged the squeeze on its financial resources, but voiced confidence that it would overcome the crisis.
"We have lived through worse. This problem isn't any more difficult than it was in the past and will hopefully be resolved soon," he told Reuters.
Some Middle East states are continuing to help Gaza through construction programmes, with aid either coming directly in the form of building materials or via funds to the United Nations. For example, Saudi Arabia is building 1,700 housing units in southern Gaza, while Qatar is paying for a major road upgrade.
Neither country is believed to give Hamas cash assistance, although private donors in the Gulf are still helping.
An additional problem for Hamas is how to get its hands on foreign donations. Bank transfers have long been difficult because only one local bank works with Hamas and all electronic transactions are carefully monitored abroad.
Therefore, much of the financial aid from countries like Iran, some diplomats and analysts said, used to arrive stuffed into suitcases via the tunnels. That lifeline has been squeezed by the Egyptian clamp-down.
"I don't know whether I can blame the Gaza government. Where could it bring in money from? The sky?" said Abu Mohammed, a civil servant.
