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Freezing U.S. aid to Egypt would not be easy or cost-free

By Susan Cornwell and Andrea Shalal-Esa

WASHINGTON (Reuters) - Some U.S. lawmakers are calling for the Obama administration to shut off aid to Egypt in the aftermath of the army's lethal crackdown on protesters. But untangling the aid relationship with Cairo would not be simple and could be costly for the United States as well as Egypt.

A special financing arrangement Cairo uses could leave U.S. taxpayers holding the bill for billions of dollars in equipment Egypt already has ordered on credit, and companies like Lockheed Martin and General Dynamics that build military hardware for Egypt would be affected by aid restrictions.

President Barack Obama said on Thursday that normal cooperation with Cairo could not continue and announced the cancellation of military exercises with Egypt next month.

But an aid cutoff - which might see Washington losing what limited leverage it has with Egypt's interim military government - does not appear imminent.

Since 1979, when Egypt signed a peace treaty with Israel, it has been the second largest recipient, after Israel, of U.S. bilateral foreign aid, the Congressional Research Service says. From 1948 to 2011, American aid to Cairo amounted to $71.6 billion.

Lately, the U.S. aid has been running at about $1.55 billion a year. About $1.3 billion of this is military aid, which comes back to the United States in spending on things like tanks and planes.

"Most of Egypt's military assistance is captured by the U.S. defense industry that provides the platforms, maintenance and spare parts to Egypt," said Jeffrey Martini, a Middle East analyst at the RAND Corporation think tank.

"So in pure economic terms, the Egyptian military would take a hit in having less money for acquisitions but U.S. defense contractors would also lose a client," Martini said.

There were calls this week from both ends of the U.S. political spectrum for Obama to follow a U.S. law that triggers an aid cutoff if a military coup against a democratically elected government has taken place. The Obama administration says it has not determined whether the military's actions in Cairo in the departure of President Mohamed Mursi amounted to a coup.

"While President Obama ‘condemns the violence in Egypt,' his administration continues to send billions of taxpayer dollars to help pay for it," said Senator Rand Paul, a Republican with connections to the conservative Tea Party movement.

EGYPT'S CREDIT CARD

U.S. taxpayers could take a hit if the aid pipeline is shut down. A special arrangement known as cash flow financing lets Egypt and Israel make arms purchases from the United States against promises of future aid and pay for things over time - like a credit card.

The Pentagon declined to discuss what amounts might be outstanding under Egypt's cash flow financing arrangement, but analysts say it is at least $2 billion.

"So Egypt has used its credit card recently to buy an additional squadron of F-16 (fighter jets) and an additional batch of M1A1 (tank) kits," said Robert Springborg, a professor of national security affairs at the Naval Postgraduate School in Monterey, California.

"If suddenly we were to say, you are not sending those F-16s or those M1A1 kits, then the question arises what's going to happen to them. If nothing else can be found to be done with them, then the U.S. government would be liable to be sued by the manufacturers ... The estimated outstanding amounts are somewhere between $2.3 billion and $3.5 billion," Springborg said.

Under cash flow financing, multi-year contracts may be signed and payment schedules are prepared. This allows for the award of contracts that are more than the annual appropriation for a country, as long as the payments estimated in the out years are within the traditional amount of aid. Springborg said Egypt had contracts going out until 2017.

Democratic Senator Patrick Leahy, who chairs the Senate subcommittee in charge of foreign aid, has long been a critic of the cash flow financing.

"This arrangement, which has been on autopilot for decades, has gotten us into a situation where we have mortgaged ourselves well into the future for equipment which is not necessarily needed, for a military that can't be trusted, and that is costing us huge amounts of money," he said in a statement emailed to Reuters.

Cutting military aid to Egypt also would leave some U.S. defense companies looking elsewhere for clients. Joel Johnson, an analyst with the Virginia-based Teal Group, said it could lead to layoffs in Lima, Ohio, where General Dynamics Corp is building kits to upgrade 125 M1A1 Egyptian tanks.

Johnson said a U.S. aid shut-off also would hit small to medium-sized suppliers that provide components for the tank, which are often more vulnerable than the prime contractors. One industry official said some 500 suppliers could be hurt.

General Dynamics won the tank contract valued at $395 million in 2011. It builds the hulls and various parts and then ships the kits to Egypt for final assembly, said company spokesman Rob Doolittle. He declined to comment on the possible impact of a decision to cancel the Egyptian tank order.

The Lima facility has been counting on foreign orders and smaller contracts with the U.S. government to remain open, given the U.S. Army's plans to "pause" production of heavy ground vehicles for the United States.

Obama's announcement Thursday that the United States was canceling joint military exercises with Egypt was the first significant U.S. move to penalize Egypt's military rulers after the ouster of Mursi. Previously, the U.S. government had announced a decision to halt delivery to Egypt of four U.S.-made F-16 fighters.

Fort Worth-based Lockheed Martin is under contract to supply 20 F-16s to Egypt at a cost of $776 million. Spokesman Ken Ross said 14 of the planes have been delivered through June 30, including seven this year.

(Editing by Warren Strobel and Bill Trott)

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