By Arshad Mohammed and Lesley Wroughton
WASHINGTON, Aug 15 (Reuters) - By canceling a military exercise with Egypt but not cutting off U.S. aid, President Barack Obama sought on Thursday to show his displeasure at the Egyptian army's violent crackdown on protesters - without totally alienating the generals.
Obama announced the move a day after at least 623 people were killed, according to Egypt's Health Ministry, as troops and police used force against protesters seeking the return of President Mohamed Morsi, who was toppled by the military on July 3.
Critics argued that Obama had done too little, too late and that his administration has repeatedly sent mixed messages - among them its failure to brand Morsi's ouster a military coup - thereby eroding its ability to influence events.
A bipartisan group of U.S. Middle East experts said the cancelling of the military exercise was necessary but fell far short of what is needed to meet U.S. objectives in Egypt
"The president's failure to suspend aid to the Egyptian military is a strategic error that undercuts those objectives and weakens U.S. credibility, after repeated calls by the U.S. administration for Egyptian authorities to avoid bloodshed have been disregarded," members of the Working Group on Egypt said in a statement.
Former U.S. officials said Obama's decision reflected his balancing act since the army ousted Egypt's first freely elected president, an action the United States appeared to tacitly condone by its decision not to call for Morsi's restoration.
The White House has tried to appear to support democracy in Egypt, while protecting the U.S. strategic interest in Egypt's stability, its peace treaty with Israel and its military cooperation with the United States, including privileged access to the Suez Canal.
In his desire to maintain some links to Egypt's generals, Obama on Thursday canceled the biennial Bright Star military exercise with Egypt rather than cut the $1.55 billion in aid - including $1.3 billion to the military - that Washington gives Cairo annually.
GOOD OPTICS, LOW COST?
A former senior U.S. military official said Bright Star had long since lost any luster for the Pentagon, which sees it as an antiquated, largely tank-on-tank exercise out of sync with the U.S. military focus on counter-insurgency and counter-terrorism.
"This was a very low-cost, almost irrelevant move (by) the administration because the exercise is inconsequential and in some ways irrelevant," said the former official. "This makes for good optics, but it doesn't have any costs associated with it."
A second former U.S. official said that in calling off the exercise, the Obama administration appeared to have found "an instrument that is useful, without being damaging to the overall relationship with the military."
U.S. Defense Secretary Chuck Hagel issued a statement on Thursday saying he had called Egypt's army chief General Abdel Fattah al-Sisi and warned him the recent violence was putting defense cooperation with Egypt at risk. But he said Washington would maintain its military relationship with Cairo.
Several former U.S. officials, speaking on condition of anonymity, said the Obama administration seemed to have concluded that it has relatively little influence over the generals, who regard themselves as being in a life-and-death fight against Egypt's Islamists.
"I don't think it's going to have any meaningful impact on their behavior," said the second former official. "I believe they have decided that it is in their interest to get a grip on this situation, control it and then master it."
In a statement released in Cairo on Friday, Egypt's presidency said Obama's remarks condemning the crackdown were not based on "facts" and would strengthen and encourage violent groups.
"The Egyptian military views this as an existential struggle," said a third former senior U.S. official. "While our assistance is desirable, it is not existential."
The former officials also stressed that Egypt's army has the backing of key Gulf Arab states, including Saudi Arabia, Kuwait and the United Arab Emirates, which have promised the military-backed government some $12 billion in financial support.
In a statement released on Thursday, the UAE foreign ministry made no secret of where its sympathies lay.
"The UAE Ministry of Foreign Affairs re-affirms its understanding of the sovereign measures taken by the Egyptian government after having exercised maximum self-control," it said in a statement posted on its website.
"What is regretful is that political extremist groups have insisted on the rhetoric of violence, incitement, disruption of public interests and undermining of the Egyptian economy, which has led to the regretful events," it added.
The financial assistance already provided by the Gulf states dwarfs the U.S. aid.
TIGHTROPE OR RAZOR BLADE?
Amy Hawthorne, a senior fellow at the Atlantic Council's Rafik Hariri Center for the Middle East and member of the Working Group on Egypt, said the Obama administration's response to the violence was inadequate and sent mixed messages.
"What Obama is trying to do is tread this cautious path between taking too strong of a path in either direction, which is understandable given the pressures he trying to balance," said Hawthorne, a former State Department official.
"But at a certain point we have to look at this with more clarity. The current approach hasn't been working and it's time to try something else to send a stronger message," she added.
The first former U.S. official said Washington had managed to alienate all major parties by trying to strike a middle ground.
"We have alienated the military because of our stand on democracy, we have alienated the Muslim Brotherhood because of our stand on interests," he added. "And trying to walk that thin line unfortunately has not been a tightrope for the president, but has ended up being a razor blade." (Additional reporting by Andrea Shalal-Esa; Editing by Warren Strobel and David Brunnstrom)