A spokesperson for Arafat made the announcement on Tuesday from Palestinian Authority (PA) building in Ram Allah.
''President Arafat and the Fatah central committee have unanimously asked Abu Ala (Quraya) to form a new cabinet'', said Foreign Minister Nabil Shaath.
According to the Palestinian Authority, Quraya has agreed to stay on after the one-month term of his emergency cabinet comes to an end next week.
Qaraya was appointed prime minister in September, following the resignation of Muhammed Abbas, who claimed that his authority was being undermined by Arafat.
He had agreed to take over as prime minister on a temporary basis, but became frustrated at the slow pace of reform within the PA.
He had also threatened to resign in October, telling Arafat ''I want you to relieve me of this job'' following on from a meeting with Arafat in Ram Allah.
Quraya was said to be angered by Arafat's constant interference over matters relating to appointment of a Palestinian cabinet.
Quraya was one of the architects of the flawed Oslo accords, signed with Israel in 1993 that was supposed to lead to limited Palestinian autonomy in the West Bank and Gaza Strip.
His close relationship with Yasir Arafat lead to widespread criticism from the Israeli and American governments, who say that Arafat should be doing more to reign in resistance groups.
However, weeks into his role as prime minister, Quraya was heading for a collision course with Arafat over his decision to appoint Nasir Yusuf as the head of the Palestinian security forces.
The relationship between the two men has been strained, as rumors of Quraya's resignation began to take circulate in PA circles.
Today's announcement does not make it clear how long Quraya has decided to stay on as prime minister.