CAIRO (Reuters) - Egypt's decision to scrap plans to borrow from the International Monetary Fund may slow an economic recovery, delay a solution to a potential fiscal crisis and make it harder for future governments to access credit.
Egypt had sealed a $3 billion (1.9 billion pound) financial package on June 5 to shore up its finances after the protests that ended Hosni Mubarak's 30-year rule scared away tourists and investors, two of its main sources of foreign exchange.
But over the weekend, Finance Minister Samir Radwan said Egypt would not need to borrow from the IMF or the World Bank, which had also offered a large lending package, asserting that the shortfall could now be covered locally and from foreign aid.
"It is totally unwise for them to refuse this IMF money," said one Western banker. "Even if they had been promised (funds) from other sources to fill external and fiscal gaps, it would have been a lot better for them to depend on the IMF."
He said IMF guidance would have reassured other investors.
But Egypt's ruling army council, which took control after Mubarak, may be reluctant to be tied even to the lenient terms offered by the IMF as it seeks to avoid any foreign interference after Egyptians toppled Mubarak who had close ties to the West.
Egyptian credit default swaps were trading at 308.7 on Tuesday, up from 304.7 on Friday, according to data provider Markit. They rose as high as 441 in late January as the revolt against Mubarak was growing.
The yield on Egypt's 5.75 percent, 10-year dollar bond was at 5.759 percent, up from 5.701 on Friday.
"There has been an increase in a nationalistic attitude, 'we can do it ourselves'," said one Western diplomat, who declined to be named because of the political sensitivities.
The government forecasts that its revised budget will cut the deficit for the fiscal year starting July 1 to 8.6 percent of gross domestic product from a previously predicted 11 percent, but has given few details of how it will achieve this.
Economists questioned whether it could narrow the deficit at a time when the economic slowdown has cut tax revenue and when calls for higher wages from state employees and for higher subsidies on basic commodities are piling on spending pressure.
A parliamentary election in September is adding political uncertainty to investors' concerns.
The Finance Ministry said this month the economy contracted in the first six months of 2011 and was likely to grow only 3.2 percent in the 2011/12 financial year, compared with the 6 percent growth that Mubarak's government had predicted.
"The current fiscal forecasts are based on this notion that they will increase their revenues, and also they'll be able to maintain their expenditures. Time will tell if this would work," said John Sfakianakis, an economist with Banque Saudi Fransi.
"It's a first forecast, and usually the first forecast by anybody tends to be either an overshoot or an undershoot."
Egypt approached the IMF and international donors in early May to help it plug an estimated $11 billion balance of payments gap in 2011/12 caused by the political turmoil.
Later in May it approved a budget for 2011/12 that boosted spending by a quarter, partly to help the poor. Then it sealed its $3 billion IMF pact in June to help fund the deficit.
Donor sources said the terms of the deal were among the easiest ever approved by the IMF, with Egypt repaying the funds in between 3-1/4 and five years at a variable interest rate starting at 1-1/2 percent.
The finance minister described the terms as "extremely lenient. They didn't put conditions, they put benchmarks."
But he told Reuters that budget revisions, agreed after a national dialogue and reflecting the army council's concerns about passing a big debt burden to the next government, meant the funds would no longer be needed to finance the deficit, which would be covered locally and from foreign commitments.
He said Egypt, as a member of the IMF, had the right to return to the Fund in future. "What we are doing now is getting technical assistance from them," he added.
The IMF's board had been due to meet to approve the deal in mid-July, with the first tranche of funds made available the same day and subsequent tranches paid quarterly over 12 months. Egypt had initially said it wanted the cash as soon as possible.
Economists said the funds would have underpinned a state-led fiscal stimulus when poor business confidence and a slow economy mean business is unwilling or unable to boost its activity and when the official unemployment rate has surged to nearly 12 percent.
"It was important to get external assistance as soon as possible and it seemed to me the IMF and World Bank had committed a fair amount of money," said Cem Akyurek, an economist with Deutsche Bank.
"So it was important for Egypt to get the money as quickly as possible to start a recovery."
Instead, by chopping spending and raising taxes, the government could reduce the amount of income tax it will collect over the coming year, casting doubt on its fiscal projections.
"The question is, is the deficit really reduced? Because it could also be window dressing. We don't know yet where the lowering of the deficit comes from. But even if it turns out to be real deficit reduction, it's not necessarily good for the economy," said a Western diplomat.
Diplomats and economists say the World Bank and other international donors, as well as commercial banks, usually look to the IMF as a seal of approval for lending to governments.
The World Bank had said it would offer $4.5 billion over the next 24 months, including $1 billion to help cover next year's budget shortfall. It now says it will review the plans after Egypt said it no longer wanted the IMF money.
Egypt on June 9 had also requested funds from the European Union for microfinance assistance designed to complement the IMF programme, but if no IMF agreement is signed these will not be made available, the diplomat said.
With additional reporting by Tom Pfeiffer; Editing by Edmund Blair; Editing by Ruth Pitchford