The European Union warned Egypt on Wednesday it could lose funds from its 5 billion euro ($6.5 billion) aid package if democratic reforms fail to satisfy Brussels, and said Cairo has already lost some additional funding.
In a report on reforms in Eastern Europe, the Middle East and North Africa, the European Commission said Cairo has shown insufficient progress since the 2011 revolt that overthrew President Hosni Mubarak and handed power to the Islamist Muslim Brotherhood movement.
It listed "serious setbacks" in areas such as human rights, and criticised Egypt's President Mohamed Mursi for pushing through constitutional changes that have plunged the country into "a deeply divisive political crisis".
Failure to address EU concerns could result in cutbacks in aid for Mursi's cash-strapped government, the EU's commissioner for enlargement, Stefan Fuele, told a news conference.
"Egypt has to deliver for those up to 5 billion euros this year and next," he said. "This is the way how we could strengthen our point."
Fuele said the EU has already stopped payments from an aid fund that makes specific links to democratic reforms, known as "more for more". The fund was set up in the aftermath of uprisings in North Africa in 2011, when the EU overhauled its aid policies to correct past failures in promoting democracy.
"Egypt has not been one of those countries benefiting from the 'more-for-more' principle and extra resources," Fuele said.
The Commission, the EU executive, said Mursi needs to improve dialogue with opposition parties and religious groups to "ensure that the Constitution is co-owned by all Egyptians".
It wants to see Egypt abandon the practice of using military courts to judge civilians and create conditions for non-governmental institutions to function according to international standards, the Commission said in the report.
It also urged Mursi's government to put in place a social safety net, ensure macroeconomic stability and strengthen public finances, as well as work towards a free-trade deal with the EU.
Addressing Mursi's achievements, the Commision listed the lifting of the state of emergency in Egypt, and an "orderly" organisation of elections.
EU diplomats say Brussels' relationship with Cairo is complicated by the desire to maintain good relations with the government, in part because of its role in regional diplomacy, particularly relations between Israel and the Palestinians. ($1 = 0.7722 euros) (Additional reporting by Adrian Croft and Ethan Bilby; editing by Ron Askew)
