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Despite turmoil, major lending effort aims to boost Egypt, Arab neighbors

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The United States and a coalition of international lenders are pushing ahead with billions of dollars in loans and other help for Egypt and neighboring states, despite the region’s sometimes violent political turmoil, hoping to head off a destabilizing economic collapse.

The risks involved in the effort have been on sharp display in Egypt in the clashes between protesters and forces loyal to President Mohamed Morsi, whose Islamist government must be trusted by the United States, the International Monetary Fund, the World Bank and others to deliver on commitments made in return for international support.

Diplomats and others involved in crafting the IMF program acknowledge that they are dealing with an unpredictable situation. Although agencies such as the IMF and the World Bank officially eschew politics in evaluating loans and projects, conditions in the Arab Spring states are particularly volatile. The uprisings in the region have produced grass-roots democratic movements applauded by the United States, but have also strengthened Islamist parties and led to violence such as the September attack on the U.S. diplomatic outpost in Benghazi, Libya.

Egypt, in particular, remains a mystery. Morsi is seeking to maintain a moderate stance internationally while remaining aligned with the country’s formerly outlawed Muslim Brotherhood. Over the past three weeks, he won praise for helping broker a cease-fire between Israel and Hamas, unnerved potential lenders with his move to seize powers from the judiciary and resorted to martial law ahead of a referendum on a proposed constitution.

The IMF had hoped to move forward this month on a $4.8 billion loan that Egypt desperately needs, as its foreign currency reserves dwindle and international investors pull money from the country. But over the weekend, Morsi reneged on imposing tax increases that the IMF had expected as a way to help bring down the country’s budget deficit.

On Tuesday morning, the IMF said that the Egyptian government had asked to delay further work on the loan “in light of the unfolding developments on the ground.” The tax hikes faced a public backlash at a time when Morsi is also trying to quell opposition to a proposed new constitution.

Egypt’s potential creditors say the situation has left them with a difficult choice: Take a chance on Morsi, or leave the country without a lifeline and surrender the ability to influence the government’s direction.

“Are these guys ready to change? The previous models . . . are not delivering anymore,” said Adnan Mazarei, deputy director of the IMF’s Middle East, North Africa and Central Asia Department. “The countries need to make drastic changes. . . . It means sectors don’t get set aside for connected people. It means banks don’t give favors. The fund recognizes it has to do something. Maybe in the past we should have pushed harder.”

The World Bank and the IMF have written extensively on the problems in the region: non-oil exports that collectively are smaller than Switzerland’s; a dearth of jobs for young people; closed and often state-dominated economies in which rulers dole out perks to favored allies. Because leaders, including now-ousted Egyptian president Hosni Mubarak, have used food and fuel subsidies to make up for the lack of opportunity among the poor and middle class, governments in those countries must finance what have become unaffordable benefits or risk political backlash if they are cut. Attempts to reduce fuel subsidies in Jordan have rocked that usually stable monarchy in recent months.

The effort to steer the region toward more open economic policies has been under discussion since the regimes in Tunisia and Egypt fell nearly two years ago and governments in Jordan, Morocco and elsewhere came under pressure to make changes.

But it is only now taking shape in full, as a broad coalition, including the United States, European nations, the European Bank for Reconstruction and Development (EBRD), the African Development Bank and others try to ensure that the region’s new leaders don’t simply supplant the old brand of cronyism with new faces and new beneficiaries.

The IMF loan to Egypt is expected to come with strict conditions attached, including a sharp curb on the use of subsidies. World Bank efforts in Tunisia are focused heavily on issues at the intersection of economics and politics, such as freedom of association and transparency in public budgeting. A request from Egypt for as much as $2 billion in similar governance support from the World Bank is being evaluated.

The EBRD, created after the fall of the Berlin Wall to finance economic transition in Eastern Europe, is funding small-business development projects in Morocco and a power plant in Jordan. By 2015, officials at the bank say, it is expected to be investing upward of $3 billion a year in Egypt, Morocco, Jordan and Tunisia.

That broad effort is proceeding despite the large degree of uncertainty about the direction of the region’s politics and leadership. It remains unclear, for example, how committed new rulers are to issues such as the education of women and their empowerment in the workplace.

Morsi’s “renaissance” program for Egypt includes pledges to boost the share of economic output in private hands, attract more foreign investment and “limit the role of the state.”

Local analysts such as Rashad Abdou said they are skeptical and think Morsi is piling on IMF and other debt without a clear long-term plan.

“They are only providing short-term solutions,” Abdou said.

But U.S. and other officials involved in the discussions with the Morsi government use words such as “pragmatic” to describe the approach to economic policy: The Egyptians are aware that outside help is needed to stabilize the country and appear willing in general to meet the conditions. That marks a change from a year ago, when the military council then running the country refused IMF help.

Support from the United States, the major shareholder in the IMF and the World Bank, is crucial. The Obama administration separately is planning $1 billion in debt forgiveness for Egypt.

Decades of diplomacy and billions of dollars in foreign aid were invested in an effort to persuade the Mubarak regime to clamp down on corruption, end the economic perks and sinecures he dispensed to remain in power, and open the economy. The results were decidedly mixed. Although Morsi remains unproven, international officials think now is the moment when outside help could have the maximum effect.

“We had a sense that as these revolutions happened, there were risks, but also a strong upside potential” to work on governance, accountability and other areas that the region’s ousted rulers had declared off-limits, said Manuela Ferro, the World Bank’s director of poverty reduction and economic management in the Middle East and North Africa.

Ingy Hassieb in Cairo contributed to this report.

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