"Don't hide behind another candidate," Iemma told reporters on Sunday. "If you want to challenge, challenge yourself."
"I love Australia and its people and he doesn't. I believe that the great majority of people in my electorate won't be voting for lunacy, no matter who is putting it forward."
Iemma's western Sydney electorate is home to a large number of Muslims.
On Sunday, the Islamic Friendship Association said it was considering whether to put up candidates at the elections in New South Wales, Australia's most populous state.
Kaysar Trad, the association spokesman, told reporters: "We need to make sure we are taken seriously.
"Not only in terms of getting them to stop picking on us every time there is an issue, but also in terms of acknowledging that there are strong candidates who are capable of serving this nation in the political arena."
Trad said that without political and economic might, Muslims in Australia would continue to face prejudice.
Hilaly's outspoken condemnation of the US war in Iraq regularly stirs anti-Muslim feeling.
In November, the Egyptian-born cleric was accused of justifying rape after a sermon in which he likened unveiled women to uncovered meat.
After that controversy, Hilaly left Australia for the Middle East, with some politicians calling on him not to return.
Even there Hilaly made headlines, telling Egyptian television that Muslims had a greater right to be in Australia than white Australians of convict heritage.
Last week more fuel hit the flames when it became known that Sheik Feiz Mohammed, head of the Global Islamic Youth Centre in Sydney's western suburbs, had urged children to be Islamic martyrs and referred to Jews as pigs. The exhortations came in DVDs titled the "Death Series".
Feiz has lived in Lebanon for the past year.