Sept 6 (Reuters) - Egypt's politics have transformed since Hosni Mubarak's overthrow last year that led to free elections and the nation's first civilian, Islamist president who has pushed the army out of day-to-day government.
But the economy, once a darling of frontier market investors, has been hammered by the months of turmoil, Islamists and liberals are still wrangling over a constitution, and the rise of the Muslim Brotherhood has raised worries in Israel about the fate of its 1979 peace treaty.
Below are the main political risks for Egypt:
ECONOMIC REFORM AND THE IMF
Egypt has received billions of dollars in aid pledges from Gulf states to shore up its shaky finances in the short term and is in talks for a $4.8 billion International Monetary Fund loan, seen as crucial in building confidence in the government's commitment to reforms such as reining in a huge subsidy programme.
But the government must balance tough reforms with the need to deliver swift economic benefits to an expectant population, many of whom live in dire poverty. Investors, meanwhile, still worry that the Egyptian pound is overvalued against the dollar.
What to watch:
- Signs of an improvement in foreign reserves that cannot be attributed to one-time injections of Gulf or other aid. Reserves have plunged to about $15 billion, less than half the level they were before the anti-Mubarak uprising erupted in January 2011.
- More pound weakness. President Mohamed Mursi ruled out a devaluation on Aug. 27 but the currency has weakened since then, suggesting the authorities may be quietly letting it fall. More substantial falls may start enticing investors.
- Introductions of smart cards or coupons for buying cooking gas, diesel or gasoline, all heavily subsidised. That could signal government determination to implement serious reforms.
- Signs of an uptick in protests where the focus is on food prices or wages, not politics. That could put pressure on the government to ease off any reforms or austerity measures.
TUSSLE WITH THE ARMY
Within weeks of taking office, Mursi had confronted the generals, who had been in day-to-day charge after Mubarak fell and had for six decades been the power behind presidents who had suppressed Islamists. His moves clawed back powers they had sought to deny Mursi as he was being elected.
Discontent among second-tier officers may have helped Mursi sweep out the top brass on Aug. 12 and issue a decree that stamped his authority on the nation and its military. But the army retains a powerful influence over national security and holds business interests that range from making arms to bottling water that it is likely to guard jealously.
What to watch:
- Any move by Mursi to rein in the military's business interests or subject its budget to scrutiny. That could generate a fresh confrontation between the army and the president.
TIES WITH ISRAEL
Israel is wary of the rise of the Muslim Brotherhood, the group that won most seats in Egypt's election and which propelled Mursi to power. The group, which also inspired Islamist Hamas in Gaza, describes Israel as a racist and expansionist state.
Yet, Mursi has repeatedly said he respects Egypt's treaties, a way of reassuring Israel without mentioning it by name. In addition, worries that a flare-up in Sinai - where Islamic militants have gained a foothold on the border with Israel -could be a flashpoint have so far proved unfounded.
What to watch:
- Any fresh clash on the Sinai border. Both sides reacted with cool heads when militants killed Egyptian border guards in a raid in August. But diplomats say the chance of miscalculation and an unwanted escalation has not gone away.
- Easing Gaza border passage. There is little sign so far that Mursi wants a more open border as a gesture to Islamists ruling Gaza. Any loosening may show he is challenging Egypt's security services, which have kept tight controls.
Islamists swept up most seats in parliament, which was later dissolved based on a court order under army rule, and an Islamist also won the presidency, yet a big chunk of the population including Christians - a tenth of Egypt's 83 million people - and some Muslims remain wary of their rule.
The battle to shape the new Egypt is being fought in an assembly drawing up the new constitution. The role of Islam is at the centre of the debate. Without a new constitution, no new elections will be held and both executive and legislative authority stays with the president, a worry to liberals.
What to watch:
- Liberals or opponents of Mursi organising more effectively on the street or in political parties. So far, their challenge has been muted, but could pick up if Mursi's reforms start to bite or he becomes more aggressive in imposing Islamic laws.
- Progress in the constituent assembly. How willing will ultraorthodox Salafi Islamists, a group that secured the second biggest bloc in the parliament vote, be to compromise over calls for a bigger role for Islam in the constitution? (Writing by Edmund Blair; Editing by Louise Ireland)