For the 1.3 million Arabs of the occupied West Bank and Gaza Strip, who have watched Israel's six-week-old political deadlock from the closest and most uncomfortable of vantage points, the crisis has been a source of despair.

The hope of Arab moderates that Israel's left-leaning Labor Alignment would win a large mandate in the July 23 elections that would enable it to pursue a new peace initiative in the region was dashed by the inconclusive election results.

Instead, Labor leaders have publicly eschewed talk of new diplomatic moves or of trading West Bank territory for peace as they have attempted to attract conservative partners to form a ruling coalition.

At the same time, Arab fears have been heightened by the increased parliamentary vote for right-wing Jewish extremists, including the unexpected electoral victory of Rabbi Meir Kahane, who ran on a platform advocating forcible expulsion of all Arabs from Israel and the occupied territories.

The Arab radicals here, who say they never held hope that a Labor-led government would mark a real improvement over the present Likud, contend that their darkest predictions have been vindicated.

"What's happening on the Israeli political scene has given new credibility to Arab radicals," said Mohammed Shadid, chairman of the political science department of Al Najah University here. "The trend in Israel seems toward the right and more and more intransigent."

The scene outside Israel appears equally gloomy to the Palestinians. Political leaders in the United States and Western Europe appear to have lost interest in their plight, while the Palestine Liberation Organization's leaders are badly divided.

The result, moderates and radicals alike agree, is an atmosphere in which patience and hope have given way to pessimism. Seventeen years after the Israeli military occupation began here, they see prospects for a settlement that would end or at least reduce Israeli control here as further away than ever.

"With every passing day we are losing ground," said Mayor Elias Freij of Bethlehem, considered one of the region's leading Arab moderates. "I believe the situation has reached midnight. In a few years, the people of the West Bank and Gaza may be totally forgotten."

By objective measurements, life under occupation constitutes a viable existence. Israeli administrators proudly point out that there is virtually total employment in the region, that its residents are closing the income gap with the Israelis and that probably -- given the rampant deterioration of Israel's economy -- they are in better financial shape than their Jewish neighbors. Even under occupation, the Israelis argue, the Palestinians here are no less free than their brethren in the rest of the Arab world, where western-style democracy and free elections are largely absent.

But by the criteria of those who live here, occupation remains both a hardship and a punishment, a series of small confrontations and occasional indignities. Every Israeli Army traffic checkpoint, every announcement of a new or expanded Jewish settlement becomes a symbol of repression, every rock-throwing incident a symbol of resistance.

Seemingly commonplace public events become political battlefields. The Israelis recently announced plans to link this city, the West Bank's largest, to Israel's national electricity grid, a move they said would reduce costs and increase efficiency. But the idea was immediately denounced by local Arab leaders as yet another effort to increase Arab dependency.

"They want to control everything in our daily lives," said former Nablus mayor Bassam Shaka, who was deposed by the occupation administration in 1982 for alleged PLO sympathies.

A few blocks north of Shaka's house lie the locked gates of Al Najah, the largest university in the West Bank. It has been closed since late July, when Israeli soldiers entered the campus and seized large quantities of posters and pamphlets that they described as "hostile and inflammatory nationalistic material calling for armed struggle and support for the PLO." The school was closed for four months, the second time in less than a year it has been shut down for a prolonged period.

The Israelis, who agreed to the establishment of four West Bank universities during the last decade, contend the schools have become breeding grounds for radicalism and violence where academic studies have become irrelevant. "We thought education might lead to coexistence," said an official. "Instead, the schools have turned into battlefields between factions of the PLO."

But the periodic closings here and at Bir Zeit and Bethlehem universities have become part of the rhythm of life under occupation and have had a depressing effect on radicals and moderates alike. Hikmat Masri, chairman of the board and main founder of Al Najah, a former speaker of the Jordanian Parliament and a leading Arab advocate of peace talks with Israel, said the Israelis "are punishing the entire university because of a few troublemakers. Education is so important to us, and this closing is a disaster."

Masri says he prayed for a Labor Alignment electoral victory and calls Labor leader Shimon Peres "a very farsighted man who is looking for a compromise for his people." But he says he has lost hope that a new coalition government, consisting equally of Peres' supporters and those of the Likud, will make any moves that could produce a breakthrough or even change the atmosphere at his university.

He and other West Bank leaders also expressed disappointment over the likelihood that the new government will do little to curb the development of Jewish settlements in the West Bank. The numbers are relatively small -- there are estimated to be no more than 30,000 Jewish settlers, and their ranks are expected to increase very slowly over the next few years due to Israel's economic problems.

At the same time, however, small but highly visible groups of Jewish ultranationalists have started moving into areas of maximum contact and potential friction between Arabs and Jews. Between 200 and 300 have settled in the heart of the Arab city of Hebron, where they are reclaiming land owned by Jews before a 1929 pogrom. A smaller group recently took over some land near Joseph's Tomb, a biblical site on the outskirts of Nablus. Some speak of forming vanguard communities in every Arab city.

"Hebron is the prototype of what will happen throughout the West Bank," said Meron Benvenisti, a Jewish social scientist and vocal critic of occupation who has spent several years studying and writing about the West Bank.

Benvenisti argues that Jewish settlement and economic inroads into the West Bank and Gaza have reached a point of no return which elections would not have altered even had Labor won in a landslide. "The election results basically mean a continuation of the same trend of Israeli domination with no apparent change," he said.

He paints a grim portrait of the West Bank under permanent occupation, with local political leaders emasculated by not only the Israelis but also the Jordanians and the PLO. And he suggests that if, as he believes, Israel will prove unwilling to ever give up the territory, Palestinians should demand full political rights as Israeli citizens.

"It's time for Palestinians to explore their political options," he said. "If Israel is going to incorporate the land, make it incorporate the people as well." Few Palestinians are ready to entertain such a possibility. But many do agree that for them, the main lesson of the Israeli election is that they can no longer rely on outside events to rescue them from occupation.

"We do tend to blame surrogates for our fate," said Bishara Bahbah, editor-in-chief of Al Fajr, an East Jerusalem Arabic newspaper. "What we need is some self-criticism and reflection so that we can begin to come up with a coherent strategy to change our future."