Many Egyptians believe Sainsbury's has links with Israel, something it has consistently denied.
The decision to pull out of Egypt comes as Sainsbury's reports a healthy growth in sales across the group as a whole for the first three months of 2001.
Failure
The BBC's correspondent in Cairo, Frank Gardner said Sainsbury's had gone out on a limb in Egypt, which has no tradition of supermarket shopping.
It had faced problems last year, at the height of the Palestinian uprising, when a story went round that Sainsbury's had Jewish connections, a rumour encouraged by local shopkeepers.
Angry mobs had thrown stones at some stores and Muslim preachers had told people that shopping at Sainsbury's was sinful.
Other Western businesses were also targeted including Coca-Cola and Macdonalds.
But the anger had largely subsided, Mr Gardner said, and Sainsbury's failure to exploit such a large and apparently receptive market as Egypt must ultimately count as a management blunder.
"It is a huge blow to British business and a huge blow to ordinary Egyptians who had started to accept that this was the way to shop in the future, rather than going to tiny corner shops who were overcharging them," Mr Gardner told BBC News 24.
He added: "It is a warning that a business plan needs to be very thoroughly thought out and stuck to."
Its decision to move into the country - at a time when it was struggling to hang on to its core UK market - puzzled many analysts.
In 1999, the retailer paid £100m for an 80% share of local retailer Egyptian Distribution Group.
But within a year Sainsbury's was saying it was planning to 'dilute' its share after incurring operating losses of £10m.
Timing
Sainsbury's blamed the losses on a 'deterioration of the trading environment' in the Middle East and difficulty in obtaining new licences from the Egyptian government.
Kate Calvert, retail research analyst at HSBC bank, said of the ill-fated move into Egypt: "The timing was completely wrong. They had much bigger problems with the business declining overall."
Explaining his decision to pull out, Sainsbury's chairman Sir Peter Davis said: "It's a developing market and we went in with a very ambitious programme.
"I think we tried to go in too far, too fast."
Good relations
The food retailer said the sale of the Sainsbury business in Egypt to the company's minority partner will result in a £100 to £125m exceptional loss.
A Sainsbury's spokeswoman said the decision to go into Egypt had been taken under previous chief executive Dino Adriano.
She said the size of the potential market, the quality of the workforce, favourable investment conditions and good relations between the Egyptian and British governments, had all been factors in the decision.
"The situation was more stable when we went in there," she added.
Sir Peter, who was appointed last year to turn the retailer's fortunes around, decided it could not carry on sustaining losses in its Egyptian operations and decided to pull the plug.
Profitability
Back in its home market, Sainsbury's reported that core sales have increased by 4.8% in the first three months of the year.
Full-year sales excluding petrol grew by 1.7%, while full year sales including petrol grew by 2.3%.
It now expects to see a return to improved profitability in the second half of this year.
Sir Peter said the figures, unveiled in a trading update, were the result of promotional campaigns and the impact of stores extensions and refits.
Moving forward
Sainsbury's, which is due to report its full-year results on 30 May, said it had completed the sale of its 22 Homebase DIY stores for £156m.
Sainsbury's is the UK's second biggest grocer after Tesco and has been struggling to stop a decline in profitability and customer numbers.
Tesco is due to announce its first quarter sales and profits on Tuesday, and is widely expected to report profits of more than £1bn for the first time.