RAMALLAH, West Bank, May 16 (Jihan Abdalla/Reuters) - A Palestinian leader widely credited by the West with introducing transparency to a corruption-plagued and donor-dependent economy lost his job as finance minister in a government reshuffle on Wednesday.

Although he is relinquishing the treasury portfolio, Salam Fayyad will retain his other post as prime minister in a shakeup born of a financial crisis in the West Bank-based Palestinian Authority and a deadlock over implementing a power-sharing deal with rival Hamas Islamists who control the Gaza Strip.

Nabil Kassis, a former university president who like Fayyad is a political independent, will take over as finance minister. He will have to deal with fiscal challenges posed by a steady decline in donor funds and by Israeli trade restrictions.

The Palestinian Authority, which exercises limited self-rule in the Israeli-occupied West Bank, is relying on foreign aid to cover a 2012 budget projected to reach $1.3 billion.

An International Monetary Fund report in March estimated a financing gap of about $500 million and urged donors to make good on pledges that allow the Palestinian Authority to pay public worker salaries. Most of the aid comes from the European Union, the United States and Arab countries.

Amid the crisis, the Palestinian government has been serving in a caretaker capacity since resigning last February after President Mahmoud Abbas signed a unity deal in Doha with Hamas and announced new elections would be held within months.

But the accord with Hamas, which seized Gaza from forces loyal to Abbas's Fatah movement in a brief civil war in 2007, ran into trouble over the composition of a unity government and is now effectively frozen.

The legislative and executive system have been paralysed, Abbas told a news conference in Ramallah, the West Bank town where seven new ministers were to be sworn in later in the day.

He said the incoming government will be dismissed immediately if the political partnership with Hamas is consummated.

A source close to Fayyad said financial policies promoted by the former World Bank economist have led to negative results, including mounting debt. Hopefully a change in policies will get us out of our crisis, the source said.

Analysts said that Kassis was likely to be accepted by Western donors because he is not affiliated with either Fatah or Hamas and is respected by both Fayyad and Abbas.

Fayyad ran up against public opposition when he proposed austerity measures to tackle the debt crisis. That plan was never put into motion, but his raising of income tax rates also stirred discontent.

Nonetheless, Fayyad has won praise from the IMF for his efforts to ready Palestinian institutions for future statehood.

The new 21-member cabinet will have eight new faces and include replacements for two ministers in the outgoing government who were removed for alleged corruption.

(Editing by Jeffrey Heller and Mark Heinrich)