Cairo, Egypt (TML) – Egypt’s decision to reject loans from the International Monetary Fund (IMF) and World Bank may save the government unwelcome political controversy at home, but it risks undermining the country’s already severely strained economy, economists warned.

The terms of the IMF financing as well as the government’s plan to substitute it with lower spending and domestic borrowing remain murky. But economists said that without IMF help Egypt would almost certainly be saddled with higher debt costs and inflation. Furthermore, private business will now have a harder time raising capital for its own investment needs.

Less than three weeks ago, Cairo gratefully accepted an IMF offer to make $3 billion available at a very low interest rate of 1.5%. Egypt was also discussing a $2.2 billion two-year loan with the World Bank. But on Saturday, Finance Minister Samir Radwan said the government had changed its mind. Instead, it would cut its budget deficit for next year and borrow money at home.

“We do not need to go at this stage to the Bank and the Fund,” Radwan told the Reuters news agency.

The loans and aid are part of a wide-ranging effort by the U.S and other Western powers to help Egypt and the other Arab Spring economies make an orderly transition to democratic rule. But the assistance, particularly from the IMF and World Bank, has aroused the suspicions of many Egyptians, who fear that the aid will come with strings attached.

“There was a lot of excitement,” Magda Kandil, executive director of the Egyptian Centre for Economic Studies, told The Media Line. “They tried to appeal to these concerns saying that it was gesture of goodwill without any commitments to anything problematic.”

At the Group of Eight summit last month, leaders said that Egypt and Tunisia could receive as much as $20 billion total in loans from institutions like the World Bank

The U.S. has also promised a $1 billion debt-for-investment swap, about which few details have been given, and an additional US$1 billion in loans. Arab states, such as Qatar and Saudi Arabia, also offered support.

Egypt isn’t rejecting all of this largesse, but for now, Radwan said, instead of IMF funding Egypt would cut government spending in the next fiscal year. The original 2011/12 budget, approved June 1, contained a whopping 25% increase in spending to create jobs and subsidies for the poor. But last week just before it turned down the IMF loan, the government revised its plans, trimming 36 billion Egyptian pounds ($6 billion) from its deficit to 134 billion pounds, the equivalent of 8.6% of GDP.

In addition, the government will increase borrowing in the domestic market, Radwan said.

The problem is that borrowing in the domestic market means that Egyptian businesses will have to compete harder to get the investment capital they need to expand production and hire more people, Kandil said. She said it also threatens to add to inflationary pressures, creating a burden to Egypt’s hard-pressed poor. Government spending cuts may further undermine the economy.

With a gross domestic product forecast by the IMF of 1% this year as inflation reaches 11.5%, Egypt can’t afford to exacerbate either trend. Furthermore, another 700,000 Egyptians are entering the job market every year, further swelling the ranks of the unemployed.

While the mass protests that brought down President Hosni Mubarak are over, Egypt continues to suffer strikes, disorder and arrests of allegedly corrupt businessmen that have kept tourists and investors away.

The slowdown threatens to exacerbate the poverty and unemployment that helped spur the unrest to begin with, undermining political stability. Yet higher global prices for food and energy have forced the government to spend more on subsidies, diverting resources away from productive investment.

Egypt is already carrying about $35 billion in foreign debt and another $155 billion in internal debt, according to the Central Bank. Egyptian banks enjoy considerable liquidity that would enable them to provide more loans. But domestic borrowing will cost more than borrowing from the IMF, which will mean higher repayments for the government in the future.

“It may satisfy the financing needs of the government, but it will be problematic because you are financing at a higher cost and therefore burdening the government with future debt costs,” Kandil said.

The IMF usually conditions help on governments cutting their budgets, laying off civil servants and trimming or eliminating subsidies, earning the wrath of politicians and ordinary people targeted by the austerity measures. But the IMF’s June 5 announcement of the $3 billion in standby credit didn’t contain any explicit conditions and included the IMF view that “immediate implementation of such reforms is not feasible.”

Nevertheless, the deal did spark concerns in Egypt.

“I believe that this country’s future lies not with the same highly paid, unelected, unaccountable bureaucrats of the IMF, nor with their sacred indicators of budget deficits and market economics. Our future lies with a new home-grown economics that caters for the majority of Egyptians,” Wael Khalil, a socialist activist and blogger at Waelk.net, wrote in British daily The Guardian.

Fayza Abul-Naga, Egypt’s minister of international cooperation, felt compelled to answer critics of the deal by saying that Egypt wouldn’t “kneel” to dictations of the World Bank or the IMF. Kandil said it was possible that Cairo learned after agreeing to the IMF terms that there were indeed conditions attached that if found unacceptable.

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