The dispute, like many in the city, has taken on a global aspect, with the companies involved being sued by activists and boycotted.
The completed eight-line network, the first line of which is set to open in 2009, will link proposed settlements in Qalandia, on the outskirts of Ramallah, with those to the south of Gilo near Bethlehem.
In between it will connect the east and west of Jerusalem, running through its centre and skirting the historic Old City, with a stop to be built at Damascus Gate.
"The Israeli authorities have not been in touch at all and they are not supposed to make any changes in the occupied territories"
Samir Abu Eisheh, the Palestinian planning minister
The project has been designed, planners say, to alleviate traffic congestion in the centre of Jerusalem, but Palestinians believe it has a far deeper significance.
Ariel Sharon, the former prime minister, who signed the project off in 2005, said:
"I believe that this should be done, and in any event, anything that can be done to strengthen Jerusalem, construct it, expand it and sustain it for eternity as the capital of the Jewish people and the united capital of the State of Israel, should be done."
And the online promotion pack for the project also contains numerous quotes from Theodore Herzl, the founder of modern Zionism, a point noted by Palestinians.
Shmuel Elgrabli, the project's co-ordinator, says he "cannot answer questions about politics" but insists they are working with "Arabs" on the railway's development in east Jerusalem.
However, Samir Abu Eisheh, the Palestinian planning minister, is angry, saying he has not even been consulted.
"The Israeli authorities have not been in touch at all and they are not supposed to make any changes in the occupied territories, including east Jerusalem.
|The network will link Qalandia and |
Bethlehem, with other stops in between
"According to international law and UN resolutions, they are not allowed to make these changes.
"Its not up to them to decide what should be done in Palestinian areas - it is a Palestinian issue. It is our agenda and we should be administering and developing it."
The land on which the railway will be built in east Jerusalem is being bought using compulsory purchase orders at a fraction of the market value, reports say.
But it is set to stop at Arab areas of east Jerusalem, such as Shu'fat, home to the only refugee camp within the city's boundaries, a potential link for them to the city centre.
Nadav Meroz, a Jerusalem transport director, rejects allegations of any discrimination in the project, saying the railway is for people from "all Jerusalem's communities, including Jewish, Arabic and Christian backgrounds".
But Palestinians remain sceptical.
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Suhail Khalilieh, of the Applied Research Institute of Jerusalem, says the railway is a symbol of the discrimination inherent in the 40-year occupation of Palestinian land by Israel.
"We don't know that they are going to allow Palestinian Jerusalemites to use the light rail.
"And even if they did, if there was a security threat they would immediately suspend the service for Palestinians. There might even be separate stations for Arabs and Jews.
"It is an apartheid system and that's what happens in this kind of system."
International law is clear on the issue - the project is illegal.
Article 49 of the Geneva Conventions bans the transfer of populations of an occupying power to occupied territories, something the light rail network facilitates.
Pro-Palestinian groups are fighting back and pressure is being put on the two French companies involved in the project, Alstom and Veoila, which own the Connex rail company.
The two firms face legal action from the Association France Palestine Solidarite (AFPS) under a civil law that says contracts can be cancelled if they violate "good morals".
Neither firm could be contacted for comment for this article.
A Dutch bank, ASN, has already sold its five per cent share in Veiola, saying the railway was "not in line with the United Nations' demand to stop all support for Israel's settlement activities," the Israeli Haaretz newspaper reported.
|Alstom is under pressure from Palestinian |
groups over the rail project
And in Ireland, plans to train drivers for the light rail on a similar network in Dublin were scrapped after protests from pro-Palestinian groups and trade unions.
While in Switzerland protests took the form of direct action, as 40 activists blocked the test of a prototype train as a business exhibition in Geneva.
The protests and legal actions highlight a problem for global companies which get involved in the Israeli-Palestinian conflict.
Jamal Juma is co-ordinator of the West Bank-based Stop the Wall group, which is leading the fight against the light railway.
"Wherever they go we will chase them," he says.
Juma says a legal action campaign launched by Egyptian activists recently persuaded the Egyptian parliament to cancel a $32m Veoila contract in the country.
"We are going to go all over the world, wherever they are, chasing them," he says.
The railway highlights many of the problems that Palestinians say are caused by the occupation.
Their land has been confiscated for the building of illegal settlements and they suffer continued restrictions on their movement.
But it also highlights their peaceful struggles against what they call apartheid-style oppression - and how those struggles are now being fought internationally in a globalised world.