By Lesley Wroughton

WASHINGTON, July 23 (Reuters) - The head of the U.S. government's main global development fund said on Monday Congress would send "an appalling message" by cutting the agency's budget as planned just as it was showing progress in the battle to reduce poverty in Africa and elsewhere.

Millennium Challenge Corp. Chief Executive John Danilovich told Reuters in an interview it was too early to judge the MCC after just three years in existence.

"It communicates an appalling message to Africa, an appalling message to already existing MCC countries and to those trying to become good, secure, stable governments," Danilovich said, "It is an awful thing."

The MCC was launched by President George W. Bush to provide U.S. aid to governments of poor countries that adhere to democratic principles, sound economic policies and are serious about tackling corruption.

Typical of MCC pacts is an agreement signed with Lesotho on Monday to provide $363 million over five years to the impoverished African country battling an HIV/AIDS epidemic. The latest agreement brings to 13 the number of countries that have received aid from the MCC totaling $3 billion.

Bush requested $3 billion for the MCC for fiscal 2008 but House of Representatives appropriators cut its funding to $1.8 billion, while the Senate slashed it further to $1.2 billion amid increased expenditures for the war in Iraq.

It could be several months before the issue is finalized.

Danilovich said the $1.2 billion figure was "absolutely devastating" because the MCC needed a minimum of $1.8 billion to $2 billion to deliver aid to countries that qualified.

"Funding is the big issue and it is the critical issue for us at this point," he said, adding that the entire $3 billion sought by Bush would probably "not be forthcoming from Congress."

Without the full $1.8 billion, Danilovich said, the MCC would unlikely be able to disburse grants in 2008 to Mongolia, Tanzania, Burkina Faso and Namibia, which have already qualified.

It would further affect half a dozen more countries that want to qualify for MCC funding, including Ukraine, Moldova, Jordan, Senegal, Sri Lanka and East Timor.

While the MCC is a Bush initiative, Danilovich said it had wide Democratic support.

The proposed cuts also come at a time when China is making inroads in Africa and the rest of the developing world by offering funding in return for resources like oil and minerals to feed its rapidly growing economy.

Danilovich said countries were welcome to take money from China but it would not give them the MCC "good housekeeping seal of approval" that foreign investors were looking for.

"Chinese have one way of doing it and countries are free to accept their aid and the same goes for the French or the Japanese...," he added.

To lawmakers who argue the MCC has been dragging its feet in disbursing its aid, Danilovich said: "That's disingenuous."

"All of our money has been allocated and committed and we will have no money for 2008. It is ... awaiting disbursement (by the countries) based upon their good engagement and their capacity to absorb the money."

Danilovich said that after three years the MCC had refined its approach to aid and could prove its funding was being put to good use, whether it was for a dairy farm or higher enrollments by girls in schools.

"The program has grown by leaps and bounds, particularly in the last year and a half, as we and recipient countries have refined the process of engagement," he said.

While Danilovich acknowledges MCC's strict standards are not easy for many countries to meet, he said MCC's promise of aid was an incentive to governments to improve.

He said the MCC was also prepared to withdraw aid when government performances have slipped, such as in the cases of Yemen and Gambia.

While Gambia remains an MCC outcast, Yemen embarked on a reform program that not only won it support at a donor conference in November but also brought them back into MCC.

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