CAIRO - Egyptian authorities have committed to stop sidestepping the finance ministry to borrow billions of dollars directly from the central bank, the International Monetary Fund said in a staff report prepared for a board meeting last month.

Such borrowing risks undermining the economy by expanding the money supply, fuelling inflation and causing the exchange rate to weaken against foreign currencies, economists say.

Egypt's central bank as of February 2023 had lent as much as 765 billion Egyptian pounds ($15.9 billion) to state agencies other than the finance ministry, an apparent breach of a 2020 central bank law, said the IMF report, excerpts of which were seen by Reuters. It did not say when the lending started.

Egypt's central bank, the finance ministry and the IMF did not immediately respond to requests for comment.

The IMF board meeting on March 29 approved an expansion of Egypt's current loan programme to $8 billion, citing damage to the economy from the crisis in Gaza. The approval came weeks after Egypt struck a record $35 billion investment deal with the United Arab Emirates that eased a foreign currency shortage.

The IMF report said the central bank had yet to specify which agencies had done the borrowing. About 104 billion pounds had been repaid, and the agencies were paying interest on outstanding loans at the regular rate, it added.

"The authorities are committed to prohibiting new development lending to public agencies excluding the ministry of finance," it said.

NEW CAPITAL, MILITARY COMPANIES

In order to control on- and off-budget public sector spending, Egypt would require public entities to report investment spending to a cabinet-level committee, the report said.

These include companies controlled by the military's engineering authority and the company overseeing construction of Egypt's new capital, which is being built in the desert east of Cairo at a cost that was estimated in 2019 at $58 billion.

Total public investment spending, including that in the main budget, would be limited at 350 billion pounds in the first half of 2024 and 1 trillion pounds in 2024/25, a substantial real decline over previous years. Inflation averaged more than 30% last year.

The government in the near term has postponed any new budget sector projects, the report said.

DIVESTMENT STRATEGY

Other elements of the IMF programme include "greater transparency and control over off-budget activities, a reformed and expanded divestment programme and accelerated measures to improve the business environment and reduce the state's economic footprint", according to the report.

It said the sale of state assets had slowed since the beginning of the 2023/24 financial year, but should pick up with a weaker currency and advice from the International Finance Corporation.

The government plans eventually to pursue a sector-by-sector approach focused on large transactions that appeal to foreign investors, but would meanwhile push through advanced sales such as windfarms, a power plant and desalination plants, the report said.

The government in February issued regulations eliminating preferential tax treatment and exemptions for state companies, including ones owned by the military.

"The stage is set for a more convincing effort to start withdrawing the state and military from economic activity," the report said.

According to the report, Arab countries have said they will not withdraw $19 billion deposited with Egypt's central bank to buy stocks or debt until the end of the IMF programme in September 2026.

($1 = 48.1200 Egyptian pounds)

(Reporting by Aidan Lewis and Patrick Werr Editing by Gareth Jones)