* Central bank cuts dollars on offer at auctions
* Currency shortage hurts businesses badly
* February reserves figures expected around March 7
CAIRO, Feb 28 (Reuters) - Egypt's central bank is expected to report next week that it has slowed the rapid erosion of its foreign currency reserves but failed to halt it, despite sharp limits it has put on its sales of dollars, which economists say are punishing business.
Investment bank CI Capital bank predicted a decline of another $900 million in central bank foreign reserves to $12.7 billion for February, ahead of the publication of the figure by the central bank around March 7.
The fall in Egypt's foreign currency reserves is one of the biggest problems facing President Mohamed Mursi, who is trying to stave off economic collapse in the most populous Arab state since becoming its first elected leader last year.
Two years of political tumult and street unrest have prolonged an economic slump and wrecked the tourism sector that Egypt relies on for hard currency. Negotiations for a $4.8 billion loan from the IMF have been stalled while the country plans parliamentary elections, the sixth nationwide vote since autocrat Hosni Mubarak was toppled in a 2011 popular uprising.
Nearly two-thirds of Egypt's reserves have vanished in the two years since the revolt. Foreign reserves fell by $1.4 billion to $13.6 billion in January, exacerbated by a $650 million repayment to the Paris Club of state creditors.
Economists say the slide in reserves is now being restrained in part by the central bank's policy of limiting dollars available at auction, a policy that hurts businesses who need increasingly scarce hard currency for imports.
"We expect (reserves) to drop, but at a lower pace than last month because this month they don't have the $650 million payment for the Paris Club," said Mona Mansour, chief economist at CI Capital. "This will ease the drop a bit, as well as the (lower) amounts offered in the foreign currency auctions."
Egypt has lost about $1 billion in reserves each month since Mubarak's fall, and the situation has become critical since the start of this year, with total reserves falling below the $15 billion needed to cover three months of imports. Egypt depends on imports for food and fuel, which it makes available at heavily subsidised prices to its 80 million mostly poor people.
The slide in reserves and shortage of dollars threaten to unravel the pound currency, whose fall would lead to inflation and potentially more popular anger.
The central bank's rationing of dollars has limited the fall in the pound currency's official value to 8.2 percent since December, but has forced many traders to buy dollars on a black market where the fall has been faster.
Central bank Governor Hisham Ramez told local media on Sunday that the rate of decline in reserves could be lower for February than January but gave no further details.
Egypt has said it will reopen talks in early March to secure its IMF loan. Diplomats say a deal would unlock additional funding from a range of sources - including the World Bank, the European Union, the United States and Gulf Arab countries.
Egypt approved a draft law on Wednesday allowing the government to sell sukuk, or Islamic bonds, a measure the government said could help it raise money.
In the absence of the IMF loan deal, which officials agreed in principle last November but never finalised, the central bank has been rationing the dollar supply with auctions of limited amounts of dollars since December.
It began by selling $75 million daily to the banks, but those sales have since dwindled to just three a week, with the amount on offer reduced to about $40 million.
William Jackson, emerging markets economist at Capital Economics in London, noted that the Central Bank of Egypt (CBE) had sold only about $500 million at this month's auctions.
"In theory, the CBE's new measures should limit the fall in reserves," he said, but he added that a lack on information on flows in and out of the economy made forecasting almost impossible.
"The (reserves) drop in January was concerning given that it came against the backdrop of the CBE's tightened capital controls," said Liz Martins, senior economist at HSBC in Dubai.
"There has been no improvement since then in terms of fundamentals: the current account deficit is still wide, and there has been no aid or FDI (foreign direct investment) to offset it, as far as we are aware," she said.
Egyptian businesses, many of which are fighting for survival and desperate not to damage their reputations by letting down customers, are finding it tough to operate under such conditions.
One Cairo banker, who asked not to be identified discussing client transactions, said he had tried to secure $300,000 for a client who had been told it would take four months to get the funds through official channels.
Instead the client turned to the black market where he got the foreign currency immediately, but at 7.25 pounds to the dollar compared with the official rate of about 6.7292, an additional cost of $21,000.
Jackson noted that capital controls can cause business activity to slump.
"Egypt needs to attract more foreign capital inflows which are needed to fund the current account deficit and roll over external debt," he said.
"The longer term solution lies in restoring political stability and, most probably, securing an IMF deal."