Syrian vice president says neither side can win war

BEIRUT (Reuters) - Syrian Vice President Farouq al-Sharaa said that neither the forces of President Bashar al-Assad nor rebels seeking to overthrow him can win the war which is now being fought on the outskirts of Assad's powerbase in Damascus.

Sharaa, a Sunni Muslim in a power structure dominated by Assad's Alawite minority, has rarely been seen since the Syrian revolt erupted in March 2011 and is not part of the president's inner circle directing the fight against Sunni rebels.

But he is the most prominent figure to say in public that Assad will not win. He was speaking to the pro-Assad al-Akhbar paper in an interview from Damascus which is now hemmed in by rebel fighters to the south.

Assad's forces have used jets and artillery to try to dislodge the fighters from around Damascus but the violence has crept into the heart of the capital and rebels announced on Sunday a new offensive in the central province of Hama.

Sharaa said the situation in Syria, where more than 40,000 people have been killed, was deteriorating and a "historic settlement" was needed to end the conflict, involving regional powers and the U.N. Security Council and the formation of a national unity government "with broad powers".

"With every passing day the political and military solutions are becoming more distant. We should be in a position defending the existence of Syria. We are not in a battle for an individual or a regime," Sharaa was quoted as saying.

"The opposition cannot decisively settle the battle and what the security forces and army units are doing will not achieve a decisive settlement," he told the paper, adding that the insurgents fighting to topple Syria's leadership could plunge it into "anarchy and an unending spiral of violence".

Sources close to the Syrian government say Sharaa had pushed for dialogue with the opposition and objected to the military response to an uprising that began peacefully.

In Damascus, residents said on Monday the army had told people to evacuate the Palestinian district of Yarmouk, suggesting an all-out military offensive on the southern district was imminent.

The centre of the city, largely insulated from the violence for 21 months, is now full of army and vigilante checkpoints and shakes to the sound of regular shelling, residents say.

Queues for bread form at bakeries hours before dawn, as people seek out dwindling supplies, power cuts are increasing and fears are growing that Damascus could descend into chaos.

In a veiled criticism of the crackdown, Sharaa said there was a difference between the state's duty to provide security to its citizens, and "pursuing a security solution to the crisis."

He said even Assad could not be certain where events in Syria were leading, but that anyone who met him would hear that "this is a long struggle...and he does not hide his desire to settle matters militarily to reach a final solution."

CHANGE INEVITABLE

"We realize today that change is inevitable," Sharaa said, but "none of the peaceful or armed opposition groups with their known foreign links can call themselves the sole legitimate representative of the Syrian people".

"Likewise the current leadership...cannot achieve change alone after two years of crisis without new partners who contribute to preserving (Syria's) national fabric, territorial unity and regional sovereignty".

Rebels have now brought the war to the capital, without yet delivering a fatal blow to the government. But nor has Assad found the military muscle to oust his opponents from the city.

In Paris, Foreign Minister Laurent Fabius of France, one of the powers most insistent that Assad has lost his legitimacy, said: "I think the end is nearing for Bashar al-Assad."

On the ground, rebels said they were launching an operation to seize the central province of Hama to try to link northern rural areas of Syria under their control to the center.

Qassem Saadeddine, a member of the newly established rebel military command, said fighters had been ordered to surround and attack checkpoints across the province. He said forces loyal to Assad had been given 48 hours to surrender or be killed.

"When we liberate the countryside of Hama province ... then we will have the area between Aleppo and Hama liberated and open for us," he told Reuters.

The city of Hama in the province of the same name has a special resonance for anti-Assad activists. In 1982 Hafez al-Assad, father of the current ruler, crushed an uprising in the city, killing up to 30,000 civilians.

In Damascus, activists said fighter jets bombed the Yarmouk Palestinian refugee camp on Sunday, killing at least 25 people sheltering in a mosque.

The attack was part of a month-old campaign by Assad's forces to eject rebels from positions they are establishing around the capital's perimeter. Yarmouk, to the south, falls within an arc of territory running from the east of Damascus to the southwest from where rebels hope to storm the government's main redoubt.

MOSQUE HIT

Opposition activists said the deaths in Yarmouk, to which refugees have fled from fighting in nearby suburbs, resulted from a rocket fired from a warplane hitting the mosque.

Footage showed bodies and body parts scattered on the stairs of what appeared to be the mosque.

The latest battlefield accounts could not be independently verified due to tight restrictions on media access to Syria.

Syria is home to more than 500,000 Palestinian refugees, most living in Yarmouk, and both Assad's government and the rebels have enlisted and armed Palestinians as the uprising, which began as a peaceful street movement 21 months ago, has mushroomed into a civil war.

After Sunday's air raid, clashes flared between Palestinians from the pro-Assad Popular Front for the Liberation of Palestine-General Command (PFLP-GC) and rebels including other Palestinian fighters and some PFLP-GC fighters were killed.

In the latest of a string of military installations to fall to the rebels, the army's infantry college north of Aleppo was captured on Saturday after five days of fighting, a rebel commander with the powerful Islamist Tawheed Brigade said.

(Additional reporting by Dominic Evans; Editing by Samia Nakhoul and Anna Willard)

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Japan's LDP surges back to power, eyes two-thirds majority with ally

TOKYO (Reuters) - Japan's conservative Liberal Democratic Party (LDP) surged back to power in an election on Sunday just three years after a devastating defeat, giving ex-Prime Minister Shinzo Abe a chance to push his hawkish security agenda and radical economic recipe.

An LDP win will usher in a government committed to a tough stance in a territorial row with China, a pro-nuclear energy policy despite last year's Fukushima disaster and a potentially risky prescription for hyper-easy monetary policy and big fiscal spending to beat deflation and tame a strong yen.

Exit polls by television broadcasters showed the LDP winning nearly 300 seats in parliament's powerful 480-member lower house, while its ally, the small New Komeito party, looked set to win about 30 seats.

That would give the two parties the two-thirds majority needed to over-rule parliament's upper house, where they lack a majority and which can block bills, which would help to break a policy deadlock that has plagued the world's third biggest economy since 2007.

"We need to overcome the crisis Japan is undergoing. We have promised to pull Japan out of deflation and correct a strong yen. The situation is severe, but we need to do this," Abe said on live TV. "The same goes for national security and diplomacy."

Parliament is expected to vote Abe in as prime minister on December 26.

Analysts said that while markets had already pushed the yen lower and share prices higher in anticipation of an LDP victory, stocks could rise further and the yen weaken if the "super majority" was confirmed.

Top executives of the LDP and the New Komeito confirmed that they would form a coalition. "The basis, of course, is a coalition between the LDP and the New Komeito. But if there's room to cooperate with Japan Restoration Party, we need to do so," said LDP Secretary-General Shigeru Ishiba, referring to a new, right-leaning party that was set to pick up about 46 seats.

"I think there is room to do this in the area of national defense," he said, referring to cooperation with the Japan Restoration Party. The New Komeito is more moderate than the LDP on security issues.

DEMOCRATS' DEBACLE

Exit polls showed Prime Minister Yoshihiko Noda's Democratic Party of Japan (DPJ) winning only 65 seats, just over a fifth of its tally in 2009.

The DPJ, which swept to power in 2009 promising to pay more heed to consumers than companies and reduce bureaucrats' control over policymaking, was hit by defections just before the vote.

Party executive Kohei Otsuka told NHK that Noda would likely have to quit the party leadership over the defeat, in which several party heavyweights lost their seats.

Many voters had said the DPJ failed to meet election pledges as it struggled to govern and cope with last year's huge earthquake, tsunami and nuclear disaster, and then pushed through an unpopular sales tax increase with LDP help.

Voter distaste for both major parties has spawned a clutch of new parties including the Japan Restoration Party, founded by popular Osaka Mayor Toru Hashimoto.

LDP leader Abe, 58, who quit as premier in 2007 citing ill health after a troubled year in office, has been talking tough in a row with China over uninhabited isles in the East China Sea, although some experts say he may temper his hard line with pragmatism once in office.

"The Senkaku islands are inherently Japanese territory," Abe said, referring to the islands that China calls the Diaoyu. "I want to show my strong determination to prevent this from changing."

But he also said he had no intention of worsening relations with China

The soft-spoken grandson of a prime minister, who would become Japan's seventh premier in six years, Abe also wants to loosen the limits of a 1947 pacifist constitution on the military, so Japan can play a bigger global security role.

China's official Xinhua news agency, noting the deterioration in relations with Japan, warned it not to continue its lurch to the right.

"An economically weak and politically angry Japan will not only hurt the country, but also hurt the region and the world at large," Xinhua said. "Japan, which brought great harm and devastation to other Asian countries in World War II, will raise further suspicions among its neighbors if the current political trend of turning right is not stopped in time."

"UNLIMITED" MONETARY EASING

The LDP, which promoted atomic energy during its decades-long reign, is expected to be friendly to nuclear utilities, although deep public safety concerns remain a barrier to business-as-usual for the industry.

Abe has called for "unlimited" monetary easing and big spending on public works to rescue the economy from its fourth recession since 2000. Such policies, a centerpiece of the LDP's platform for decades, have been criticized by many as wasteful pork-barrel politics.

"Quantitative easing by the BOJ will help correct a strong yen and push up stock prices," Abe said ."That will help boost investment and lead to rises in wages, jobs and household revenues. We'd like to shorten the time needed for this to happen."

Kyodo news agency said the new government could draft an extra budget for 2012/13 worth up to 10 trillion yen ($120 billion) and issue debt to pay for it.

Many economists say that prescription for "Abenomics" could create temporary growth and enable the government to go ahead with a planned initial sales tax rise in 2014 to help curb a public debt now twice the size of gross domestic product.

But it looks unlikely to cure deeper ills or bring sustainable growth, and risks triggering a market backlash if investors decide Japan has lost control of its finances.

"It's a pretty big win for the LDP. Abe's economic policies will be implemented so the economy will improve next year. The problem is what happens after that," said Koichi Haji, chief economist at NLI Research Institute.

"Japan can't spend on public works for ever and the Bank of Japan's monetary easing won't keep the yen weak for too long. The key is whether Abe can implement long-term structural reforms and growth strategies."

Japan's economy has been stuck in the doldrums for decades, its population ageing fast and big corporate brands faltering, making "Japan Inc" a synonym for decline.

Consumer electronics firms such as Sony Corp are struggling with competition from foreign rivals and burdened by a strong yen, which makes their products cost more overseas.

(Additional reporting by Chikafumi Hodo, Yoko Kubota, Kiyoshi Takenaka, Leika Kihara and Mari Saito in TOKYO, Yoshiyuki Osada in OSAKA and Sui-Lee Wee in BEIJING; Editing by Robert Birsel and Raju Gopalakrishnan)

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Egyptians vote on divisive constitution

CAIRO/ALEXANDRIA (Reuters) - Egyptians queued to vote on Saturday on a constitution promoted by its Islamist backers as the way out of a prolonged political crisis and rejected by opponents as a recipe for further divisions in the Arab world's biggest nation.

Soldiers joined police to secure the referendum after deadly protests during the buildup. Street brawls erupted again on Friday in Alexandria, Egypt's second city, but voting proceeded quietly there, with no reports of violence elsewhere.

President Mohamed Mursi provoked angry demonstrations when he issued a decree last month expanding his powers and then fast-tracked the draft constitution through an assembly dominated by his Muslim Brotherhood group and its allies. At least eight people were killed in clashes last week outside the presidential palace.

The liberal, secular and Christian opposition says the constitution is too Islamist and tramples on minority rights. Mursi's supporters say the charter is needed if progress is to be made towards democracy nearly two years after the fall of military-backed strongman Hosni Mubarak.

"The sheikhs (preachers) told us to say 'yes' and I have read the constitution and I liked it," said Adel Imam, a 53-year-old queuing to vote in a Cairo suburb. "The president's authorities are less than before. He can't be a dictator."

Opposition politician and Nobel Peace Prize laureate Mohamed ElBaradei wrote on Twitter: "Adoption of (a) divisive draft constitution that violates universal values and freedoms is a sure way to institutionalize instability and turmoil."

Official results will not be announced until after a second round of voting next Saturday. But partial results and unofficial tallies are likely to emerge soon after the first round, giving an idea of the overall trend.

In order to pass, the constitution must be approved by more than 50 percent of voters who cast ballots. A little more than half of Egypt's electorate of 51 million are eligible to vote in the first round in Cairo and other cities.

TRANSITION

Christians, making up about 10 percent of Egypt's 83 million people and who have long grumbled of discrimination, were among those waiting at a polling station in Alexandria to oppose the basic law. They fear Islamists, long repressed by Mubarak, will restrict social and other freedoms.

"I voted 'no' to the constitution out of patriotic duty," Michael Nour, a 45-year-old Christian teacher in Alexandria. "The constitution does not represent all Egyptians," he said.

Islamists are counting on their disciplined ranks of supporters and the many Egyptians who may fall into line in a desperate bid to end turmoil that has hammered the economy and sent Egypt's pound to eight-year lows against the dollar.

"I voted 'yes' for stability," said shopkeeper Ahmed Abou Rabu, 39. "I cannot say all the articles of the constitution are perfect but I am voting for a way forward. I don't want Egyptians to go in circles, for ever lost in this transition."

Mursi was among the early voters after polls opened at 8 a.m. (1:00 a.m. Eastern Time). He was shown on television casting his ballot shielded by a screen and then dipping his finger in ink - a measure to prevent people voting twice.

One senior official in the committee overseeing the referendum said Saturday's vote could extend to Sunday if crowds were too heavy to allow everyone cast ballots in one day. Voting for Egyptians abroad that began on Wednesday has been extended to Monday, the state news agency reported.

After weeks of turbulence, there has been limited public campaigning. Opposition politicians and parties, beaten in two elections since Mubarak's overthrow, only announced on Wednesday they backed a "no" vote instead of a boycott.

Flag-waving Islamists gathered peacefully at one of the main mosques on Friday, some shouting "Islam, Islam" and "We've come here to say 'yes' to the constitution".

PALACE SIT-IN

Opposition supporters assembled outside the presidential palace, where there has been a sit-in for days. The walls of the palace, ringed by tanks, are scrawled with anti-Mursi graffiti.

The referendum will be held on two days covering different regions, with the second round on December 22, because there are not enough judges willing to monitor all polling stations after some in the judiciary said they would boycott the vote.

Egyptians are being asked to accept or reject a constitution that must be in place before a parliamentary election can be held next year to replace an Islamist-led parliament dissolved this year. Many hope this will lead Egypt towards stability.

If the constitution is voted down, a new assembly will have to be formed to draft a revised version, a process that could take up to nine months.

The army has deployed about 120,000 troops and 6,000 tanks and armored vehicles to protect polling stations and other government buildings. While the military backed Mubarak and his predecessors, it has not intervened in the present crisis.

(Writing by Edmund Blair and Giles Elgood; Editing by Andrew Heavens)

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U.S., rebels urge gloomy Moscow to help oust Assad

BEIRUT (Reuters) - Syria's rebel leadership and the United States seized on Russian pessimism over President Bashar al-Assad's future to urge Moscow to help push its ally into ceding power and end the battles closing in around his capital.

"We want to commend the Russian government for finally waking up to the reality and acknowledging that the regime's days are numbered," the U.S. State Department spokeswoman said after a senior Kremlin envoy conceded publicly on Thursday that Assad's opponents could win the 20-month-old civil war.

"The question now is, will the Russian government join those of us in the international community who are working with the opposition to try to have a smooth democratic transition?" U.S. spokeswoman Victoria Nuland added in Washington.

In Marrakech, where his new coalition won recognition from other international powers as the legitimate leadership of Syria, rebel political leader Mouaz al-Khatib said he believed Russia, ally and arms supplier to the Assad dynasty since Soviet times, was looking for ways out of its support for a lost cause.

"I believe that the Russians have woken up and are sensing that they have implicated themselves with this regime, but they don't know how to get out," al-Khatib told Reuters. He held them "particularly responsible" for helping Assad with arms but said Moscow need not "lose everything" in Syria if it changed tack.

Under President Vladimir Putin, wary since last year's Libyan war of what Russia sees as a Western drive to use the United Nations to overthrow national leaders it dislikes, Russia has blocked U.N. efforts to squeeze Assad, who has also had strong support from his long-time sponsor Iran.

But Mikhail Bogdanov, a deputy foreign minister and the Kremlin's special envoy for Middle East affairs, was quoted as saying in Moscow: "One must look the facts in the face."

"Unfortunately, the victory of the Syrian opposition cannot be ruled out." The Syrian government, he said, was "losing control of more and more territory" and Moscow was preparing to evacuate Russian citizens if necessary.

Nuland said Bogdanov's comments demonstrated that Moscow now "sees the writing on the wall" on Syria and said Russia should now rally behind U.N. efforts to prevent a wider bloodbath.

"They can withdraw any residual support for the Assad regime, whether it is material support (or) financial support," she said. "They can also help us to identify people who might be willing, inside of Syria, to work on a transitional structure."

DIPLOMACY

International envoy Lakhdar Brahimi, who has met Russian and U.S. officials twice in the past week, is seeking a solution based on an agreement reached in Geneva in June that called for the creation of a transitional government in Syria.

But Russia has repeated warnings that recognition of al-Khatib's coalition, notably by the United States, is undermining diplomacy, and rejected U.S. contentions that the Geneva agreement sent a clear message that Assad should step down.

Nuland said the Brahimi meetings could lay the framework for a political structure to follow Assad:

"We've said all along to the Russians that we are concerned that the longer that this goes on, and the longer it takes us to get to an alternative political path for Syria, the only path is going to be the military one and that is just going to bring more violence.

"We all ought to be working together."

Bogdanov, whose government has suggested that Assad himself should be allowed to see through a transition he has promised, suggested the rebels and their allies were set on a military solution and he gave little hint of detente with Washington.

"The fighting will become even more intense and (Syria) will lose tens of thousands and, perhaps, hundreds of thousands of civilians," Bogdanov was quoted as saying. "If such a price for the removal of the president seems acceptable to you, what can we do? We, of course, consider it absolutely unacceptable."

The head of NATO, Anders Fogh Rasmussen, said elsewhere: "I think the regime in Damascus is approaching collapse."

A U.S. official said: "Assad probably still believes that Syria is his and illusions can die hard. But Assad and those closest to him have got to be feeling the psychological strain of fighting a long war that is not going their way."

DAMASCUS BATTLES

But Al-Khatib, who played down Western concerns of sectarian Sunni Islamists in rebel ranks, warned that the fighting was far from over, even as it has begun to rattle the heart of Assad's power in Damascus. On Wednesday, a car bomb killed at least 16 people in a nearby town which is home to many military families.

"The noose is tightening around the regime," al-Khatib said.

"(But) the regime still has power. People think that the regime is finished, but it still has power left, but it is demoralized and however long it lasted its end is clear."

Day and night, Damascenes can hear the thunderous sound of bombardment aimed at rebel-held and contested neighborhoods.

The city's streets have now turned into a labyrinth of checkpoints and road blocks, with several major roads permanently closed off to traffic by concrete barriers.

"We escape from one place and trouble follows," said one grandmother, Um Hassan, as she described to Reuters her family's flight from one neighborhood to another as fighting seeps into the capital. "I don't know where we can keep running to."

Nonetheless, al-Khatib played down demands for their allies to provide heavier weaponry - a request long resisted by governments wary of anti-aircraft missiles and other hardware reaching Islamist rebels who might turn them against the West.

"The Syrian people ... no longer need international forces to protect them," he said, not specifying whether he meant a no-fly zone, arms supplies or other military support.

The opposition chief said he was willing to listen to proposals for Assad to escape with his life - "The best thing is that he steps down and stops drinking the blood of the Syrian people" - and outlined three scenarios for a change of power:

Al-Khatib ruled out the Russian proposal suggesting Assad hand over power to a transitional government while remaining president, saying it was "disgraceful for a slaughtered nation to accept to have a killer and criminal at its head".

The British-based Syrian Observatory said war planes bombed rebel-held eastern suburbs of Damascus on Thursday and artillery was hitting Daraya and Moadamiyeh, southwestern areas near the centre where rebels have been fighting for a foothold.

Syria has relied on war planes and helicopters to bombard rebel districts but Damascus denied accusations by U.S. and NATO officials that it had fired Scud missiles in recent days. The foreign ministry said the long-range missiles were not used against "terrorist groups," a term it uses for the rebels.

At least 40,000 people have been killed in Syria's uprising, which started in March 2011 with street protests which were met with gunfire by Assad's security forces, and which spiraled into the most enduring and destructive of the Arab revolts.

(Additional reporting by Steve Gutterman in Moscow and Andrew Quinn in Washington; Writing by Alastair Macdonald; Editing by Michael Roddy) For an interactive look at the uprising in Syria, please click on http://link.reuters.com/rut37s

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Russia says Syrian rebels might win

MOSCOW/BEIRUT (Reuters) - Syrian rebels are gaining ground and might win, Russia's Middle East envoy said on Thursday, in the starkest such admission from a major ally of President Bashar al-Assad in 20 months of conflict.

"One must look the facts in the face," Russia's state-run RIA quoted Mikhail Bogdanov as saying. "Unfortunately, the victory of the Syrian opposition cannot be ruled out."

Bogdanov, a deputy foreign minister and the Kremlin's special envoy for Middle East affairs, said the Syrian government was "losing control of more and more territory" and Moscow was preparing to evacuate Russian citizens if necessary.

Syria has relied on war planes and helicopters to bombard rebel districts but Damascus denied accusations by U.S. and NATO officials that it had fired Scud missiles in recent days.

The foreign ministry said the long-range missiles were not used against "terrorist groups," a term it uses for the rebels, who now hold an almost continuous arc of territory from the east to the southwest of Damascus.

The head of NATO said he thought Assad's government was nearing collapse and the new leader of Syria's opposition told Reuters the people of Syria no longer needed international forces to protect them.

"The horrific conditions which the Syrian people endured prompted them to call on the international community for military intervention at various times," said Mouaz al-Khatib, a preacher who heads Syria's National Coalition.

"Now the Syrian people have nothing to lose. They handled their problems by themselves. They no longer need international forces to protect them," he added in the interview on Wednesday night, accusing the international community of slumbering while Syrians were killed.

He did not specify whether by intervention he meant a no-fly zone that rebels have been demanding for month, a ground invasion - which the opposition has warned against - or arms.

He said the opposition would consider any proposal from Assad to surrender power and leave the country, but would not give any assurances until it saw a firm proposal.

In the latest blow to the government, a car bomb killed at least 16 men, women and children in Qatana, a town about 25 km (15 miles) southwest of Damascus where many soldiers live, activists and state media said.

The explosion occurred in a residential area for soldiers in Qatana, which is near several army bases, said Rami Abdelrahman, head of the pro-opposition Syrian Observatory for Human Rights.

He put the death toll as 17, including seven children and two women. State news agency SANA said 16 people had died.

State television showed soldiers walking by a partly collapsed building, with rubble and twisted metal on the road.

The pro-government Al-Ikhbariya TV said a second car bomb in the Damascus suburb of al-Jadideh killed eight, most of them women and children.

Apart from gaining territory in the outskirts of Damascus in recent weeks, rebels have also made hit-and-run attacks or set off bombs within the capital, often targeting state security buildings or areas seen as loyal to Assad, such as Jaramana, where twin bombs killed 34 people in November.

The Pakistani Foreign Office said security concerns had prompted it to withdraw the ambassador and all Pakistani staff from the embassy in the central suburb of East Mezzeh, a couple miles from the Interior Ministry.

BACK TO THE WALL

With his back to the wall, Assad was reported to be turning ever deadlier weapons on his adversaries.

"I think the regime in Damascus is approaching collapse," NATO Secretary-General Anders Fogh Rasmussen said on Thursday.

Human Rights Watch said some populated areas had been hit by incendiary bombs, containing flammable materials such as napalm, thermite or white phosphorous, which can set fire to buildings or cause severe burns and respiratory damage.

The British-based Syrian Observatory said war planes were bombing rebel-held eastern suburbs of Damascus on Thursday and artillery was hitting Daraya and Moadamiyeh, southwestern areas near the centre where rebels have been fighting for a foothold.

At least 40,000 people have been killed in Syria's uprising, which started in March 2011 with street protests which were met with gunfire by Assad's security forces, and which spiraled into the most enduring and destructive of the Arab revolts.

The United States, European powers and Arab states bestowed their official blessing on Syria's newly-formed opposition coalition on Wednesday, despite increasing signs of Western unease at the rise of militant Islamists in the rebel ranks.

Western nations at "Friends of Syria" talks in Marrakech, Morocco rallied around a new opposition National Coalition formed last month under moderate Islamist cleric al-khatib.

Russia, which along with China has blocked any U.N. Security Council measures against Assad, criticized Washington's decision to grant the coalition formal recognition, saying it appeared to have abandoned any effort to reach a political solution.

Bogdanov's remarks were the clearest sign yet that Russia is preparing for the possible defeat of Assad's government.

"We are dealing with issues of preparations for an evacuation. We have mobilization plans and are clarifying where our citizens are located," Bogdanov said.

A British Foreign Office spokesperson said the Russian position remained largely unchanged but the situation on the ground gave Moscow an interest in finding an agreed solution, even if the chances of such a solution remained slim.

"If Russia's position on Syria had been a brick wall, it is now a brick wall with a crack in it," the spokesperson said.

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North Korea launches rocket , raising nuclear arms stakes

SEOUL/TOKYO (Reuters) - North Korea successfully launched a rocket on Wednesday, boosting the credentials of its new leader and stepping up the threat the isolated and impoverished state poses to opponents.

The rocket, which North Korea says put a weather satellite into orbit, has been labeled by the United States, South Korea and Japan as a test of technology that could one day deliver a nuclear warhead capable of hitting targets as far away as the continental United States.

"The satellite has entered the planned orbit," a North Korean television news reader clad in traditional Korean garb announced, after which the station played patriotic songs with the lyrics "Chosun (Korea) does what it says".

The rocket was launched just before 10 a.m. (0100 GMT), according to defense officials in South Korea and Japan, and was more successful than a rocket launched in April that flew for less than two minutes.

The North American Aerospace Defense Command (NORAD) said that it "deployed an object that appeared to achieve orbit", the first time an independent body has verified North Korean claims.

North Korea followed what it said was a similar successful launch in 2009 with a nuclear test that prompted the U.N. Security Council to stiffen sanctions that it originally imposed in 2006 after the North's first nuclear test.

North Korea is banned from developing nuclear and missile-related technology under U.N. resolutions, although Kim Jong-un, the youthful head of state who took power a year ago, is believed to have continued the state's "military first" programs put in place by his late father, Kim Jong-Il.

North Korea hailed the launch as celebrating the prowess of all three members of the Kim family to rule since it was founded in 1948.

"At a time when great yearnings and reverence for Kim Jong-il pervade the whole country, its scientists and technicians brilliantly carried out his behests to launch a scientific and technological satellite in 2012, the year marking the 100th birth anniversary of President Kim Il Sung," its KCNA news agency said. Kim Il Sung, the current leader's grandfather, was North Korea's first leader.

The United States condemned the launch as "provocative" and a breach of U.N. rules, while Japan's U.N. envoy called for a Security Council meeting. However, diplomats say further tough sanctions are unlikely from the Security Council as China, the North's only major ally, will oppose them.

"The international community must work in a concerted fashion to send North Korea a clear message that its violations of United Nations Security Council resolutions have consequences," the White House said in a statement.

U.S. intelligence has linked North Korea with missile shipments to Iran. Newspapers in Japan and South Korea have reported that Iranian observers were in the North for the launch, something Iran has denied.

Japan's likely next prime minister, Shinzo Abe, who is leading in opinion polls ahead of an election on Sunday and who is known as a hawk on North Korea, called on the United Nations to adopt a resolution "strongly criticizing" Pyongyang.

A North Korean Foreign Ministry spokesman reiterated that the rocket was a "peaceful project".

"The attempt to see our satellite launch as a long-range missile launch for military purposes comes from hostile perception that tries to designate us a cause for security tension," KCNA cited the spokesman as saying.

"STUMBLING BLOCK"

China had expressed "deep concern" prior to the launch which was announced a day after a top politburo member, representing new Chinese leader Xi Jinping, met Kim Jong-un in Pyongyang.

On Wednesday, its tone was measured, regretting the launch but calling for restraint on any counter-measures, in line with a policy of effectively vetoing tougher sanctions.

"China believes the Security Council's response should be cautious and moderate, protect the overall peaceful and stable situation on the Korean peninsula, and avoid an escalation," Chinese Foreign Ministry spokesman Hong Lei told journalists.

Bruce Klingner, a Korea expert at the Heritage Foundation, said: "China has been the stumbling block to firmer U.N. action and we'll have to see if the new leadership is any different than its predecessors."

A senior adviser to South Korea's president said last week it was unlikely there would be action from the United Nations and Seoul would expect its allies to tighten sanctions unilaterally.

Kim Jong-un, believed to be 29 years old, took power when his father died on December 17 last year and experts believe the launch was intended to commemorate the first anniversary of his death. The April launch was timed for the centennial of the birth of Kim Il Sung.

Wednesday's success puts the North ahead of the South which has not managed to get a rocket off the ground.

"This is a considerable boost in establishing the rule of Kim Jong-un," said Cho Min, an expert at the Korea Institute of National Unification.

There have been few indications the secretive and impoverished state, where the United Nations estimates a third of people are malnourished, has made any advances in opening up economically over the past year.

North Korea remains reliant on minerals exports to China and remittances from tens of thousands of its workers overseas.

Many of its 22 million people need handouts from defectors, who have escaped to South Korea, for basic medicines.

Given the puny size of its economy - per capita income is less than $2,000 a year - one of the few ways the North can attract world attention is by emphasizing its military threat.

It wants the United States to resume aid and to recognize it diplomatically, although the April launch scuppered a planned food deal.

The North is believed to be some years away from developing a functioning nuclear warhead although it may have enough plutonium for about half a dozen nuclear bombs, according to nuclear experts.

It has also been enriching uranium, which would give it a second path to nuclear weapons as it sits on big natural uranium reserves.

"A successful launch puts North Korea closer to the capability to deploy a weaponized missile," said Denny Roy, a senior fellow at the East-West Center in Hawaii.

"But this would still require fitting a weapon to the missile and ensuring a reasonable degree of accuracy. The North Koreans probably do not yet have a nuclear weapon small enough for a missile to carry."

The North says its work is part of a civil nuclear program although it has also boasted of it being a "nuclear weapons power".

(Additional reporting by Jumin Park and Yoo Choonsik in SEOUL; David Alexander, Matt Spetalnick and Paul Eckert in WASHINGTON; Linda Sieg in TOKYO, Sui-Lee Wee and Michael Martina in BEIJING,; Rosmarie Francisco in MANILA; Writing by David Chance; Editing by Raju Gopalakrishnan and Robert Birsel)

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IMF loan to Egypt delayed as crisis deepens

CAIRO (Reuters) - A vital $4.8 billion International Monetary Fund loan to Egypt will be delayed until next month, its finance minister said on Tuesday, intensifying the political crisis gripping the Arab world's most populous nation.

As rival factions gathered in Cairo and Alexandria for a new round of demonstrations, Finance Minister Mumtaz al-Said said the delay in the loan agreement was intended to allow time to explain a heavily criticised package of economic austerity measures to the Egyptian people.

The announcement came after President Mohamed Mursi on Monday backed down on planned tax increases, seen as key for the loan to go ahead. Opposition groups had greeted the tax package, which had included duties on alcoholic drinks, cigarettes and a range of goods and services, with furious criticism.

"Of course the delay will have some economic impact, but we are discussing necessary measures (to address that) during the coming period," the minister told Reuters, adding: "I am optimistic ... everything will be well, God willing."

Prime Minister Hisham Kandil said Egypt had requested that the loan be delayed by a month.

"The challenges are economic not political and must be dealt with aside from politics," he told a news conference.

Kandil said the reforms would not hurt the poor. Bread sugar and rice would not be touched, but cigarettes and cooking oil would go up and fines would be imposed for public littering. In a bid to rebuild consensus, he said there would be a national dialogue about the economic program next week.

In Washington, the IMF said Egypt had asked for the loan to be postponed "in light of the unfolding developments on the ground". The Fund stood ready to consult with Egypt on resuming discussions on the stand-by loan, a spokeswoman said.

GUNMEN OPEN FIRE

On the streets of the capital, tensions ran high after nine people were hurt when gunmen fired at protesters camping in Tahrir Square, according to witnesses and Egyptian media.

The opposition has called for a major demonstration it hopes will force Mursi to postpone a referendum on a new constitution.

Outside the presidential palace, dozens of protesters succeeded in pushing down two giant concrete blocks forming a small part of a wall blocking access to the site.

Thousands of flag-waving Islamist Mursi supporters, who want the vote to go ahead as planned on Saturday, assembled at a nearby mosque, setting the stage for further street confrontations in a crisis that has divided the nation of 83 million.

In Egypt's second city of Alexandria, thousands of rival demonstrators gathered at separate venues. Mursi's backers chanted: "The people want implementation of Islamic law," while his opponents shouted: "The people want to bring down the regime."

The upheaval following the fall of Hosni Mubarak last year is causing concern in the West, in particular the United States, which has given Cairo billions of dollars in military and other aid since Egypt made peace with Israel in 1979.

The turmoil has also placed a big strain on the economy, sending foreign currency reserves down to about $15 billion, less than half what they were before the revolt two years ago as the government has sought to defend the pound.

"Given the current policy environment, it's hardly a surprise that there's been a delay, but it is imperative that the delay is brief," said Simon Williams, HSBC economist in Dubai. "Egypt urgently needs that IMF accord, both for the funding it brings and the policy anchor it affords."

The IMF deal had been seen as giving a seal of approval to investors and donors about the government's economic plans, vital for drawing more cash into the economy to ease a crushing budget deficit and stave off a balance of payments crisis.

MASKED ATTACKERS

In central Cairo, police cars surrounded Tahrir Square in central Cairo, the first time they had appeared in the area since November 23, shortly after a decree by Mursi awarding himself sweeping temporary powers that touched off widespread protests.

The attackers, some masked, also threw petrol bombs that started a small fire, witnesses said.

"The masked men came suddenly and attacked the protesters in Tahrir. The attack was meant to deter us and prevent us from protesting today. We oppose these terror tactics and will stage the biggest protest possible today," said John Gerges, a Christian Egyptian who described himself as a socialist.

The latest bout of unrest has so far claimed seven lives in clashes between the Islamist Muslim Brotherhood and opponents who are also gathering outside Mursi's presidential palace.

The elite Republican Guard which protects the palace has yet to use force to keep protesters away from the graffiti-daubed building, now ringed with tanks, barbed wire and concrete barricades.

The army has told all sides to resolve their differences through dialogue, saying it would not allow Egypt to enter a "dark tunnel". For the period of the referendum, the army has been granted police powers by Mursi, allowing it to arrest civilians.

The army has portrayed itself as the guarantor of the nation's security, but so far it has shown no appetite for a return to the bruising front-line political role it played after the fall of Mubarak, which severely damaged its standing.

OPPOSITION MARCHES

Leftists, liberals and other opposition groups called for marches say the hastily arranged constitutional referendum is polarizing the country and could put it in a religious straightjacket.

Mohamed ElBaradei, a prominent opposition leader and Nobel prize winner, said the referendum should be postponed for a couple of months due to the chaotic situation.

"This revolution was not staged to replace one dictator with another," he said in an interview with CNN.

Opposition leaders want the referendum to be delayed and hope they can get sufficiently large numbers of protesters on the streets to change Mursi's mind.

Islamists, who dominated the body that drew up the constitution, have urged their followers to turn out to show support for the president and for a referendum they feel sure of winning.

The opposition says the draft constitution fails to embrace the diversity of the population, a tenth of which is Christian, and invites Muslim clerics to influence lawmaking.

(Writing by Giles Elgood; Editing by Peter Graff and Will Waterman)

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Egypt army gets temporary power to arrest civilians

CAIRO (Reuters) - Egypt's government has temporarily given the military the authority to arrest civilians to help safeguard a constitutional referendum planned for Saturday, the official gazette said.

The order, gazetted late on Sunday, said the military would support police and liaise with them to protect "vital institutions" until the referendum result is declared.

The decree gave army officers the right to make arrests and transfer detainees to prosecutors.

Despite its limited nature, the edict will revive memories of Hosni Mubarak's emergency law, also introduced as a temporary expedient, under which military or state security courts tried thousands of political dissidents and Islamist militants.

But a military source stressed that the measure, introduced by a civilian government, would have a short shelf-life.

"The latest law giving the armed forces the right to arrest anyone involved in illegal actions such as burning buildings or damaging public sites is to ensure security during the referendum only," the military source said.

"The armed forces secured polling stations during previous elections when it was in charge of the country," the source said, referring to 16 months of army rule after Mubarak fell.

"Now the president is in charge. In order for the armed forces to be involved in securing the referendum, a law had to be issued saying so," the source added.

Presidential spokesman Yasser Ali said the committee overseeing the vote had requested the army's assistance.

"The armed forces will work within a legal framework to secure the referendum and will return (to barracks) as soon as the referendum is over," Ali said.

On Saturday, the military urged rival political forces to solve their disputes via dialogue and said the opposite would drag the country into a "dark tunnel", which it would not allow.

A statement issued by the military spokesman and read on state radio and television made no mention of President Mohamed Mursi, but said a solution to the political crisis should not contradict "legitimacy and the rules of democracy".

A military source close to top officers said the statement "does not indicate any future intervention in politics".

A military council took over after a popular revolt ended Mubarak's 30 years of army-backed rule last year. It then handed power to Mursi, who became Egypt's first freely elected leader in June. The military has not intervened in the latest crisis.

The army statement said the military's duty was to protect national interests and secure vital state institutions.

"The armed forces affirm that dialogue is the best and only way to reach consensus," it added. "The opposite of that will bring us to a dark tunnel that will result in catastrophe and that is something we will not allow."

Hassan Abu Taleb of the Al Ahram Center for Political and Strategic Studies said Saturday's army statement suggested the military wanted both sides to talk out their differences, but discounted the chance of direct military intervention.

"They realize that interfering again in a situation of civil combat will squeeze them between two rocks," he said.

(Additional reporting by Yasmine Saleh; Writing by Alistair Lyon; editing by Philippa Fletcher)

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Egypt's Mursi scraps decree, fails to appease opponents

CAIRO (Reuters) - Egypt's president scrapped a decree that gave him extra powers and ignited violent protests, but irate opponents said on Sunday he had deepened the conflict by pressing on with a vote on a constitution shaped by Islamists.

President Mohamed Mursi and his Islamist partisans have insisted the referendum go ahead on December 15 to seal a democratic transition that began when a popular uprising felled Hosni Mubarak 22 months ago after three decades of one-man rule.

The retraction of Mursi's November 22 decree, announced around midnight after a "national dialogue" boycotted by almost all the president's opponents, has failed to calm a war of words.

Prime Minister Hisham Kandil, a technocrat with Islamist leanings, said the referendum was the best test of opinion.

"The people are the makers of the future as long as they have the freedom to resort to the ballot box in a democratic, free and fair vote," he said in a cabinet statement.

But opposition factions, uncertain of their ability to vote down the constitution against the Islamists' organizational muscle, want the document redrafted before any vote.

Ahmed Said, a liberal leader of the main opposition National Salvation Front, said Mursi's withdrawal of his November 22 decree had not annulled its consequences, describing the race to a referendum as "shocking" and an "act of war" against Egyptians.

The Front has promised a formal response later on Sunday.

Egypt tipped into turmoil after Mursi grabbed powers to stop any court action to hinder the transition. An assembly led by Mursi's Muslim Brotherhood and other Islamists then swiftly approved the constitution it had spent six months drafting.

Liberals, leftists, Christians and others had already quit the assembly in dismay, saying their voices were being ignored.

The April 6 movement, prominent in the anti-Mubarak revolt, derided the result of Saturday's talks as "manipulation and a continuation of deception in the name of law and legitimacy".

A leftist group led by defeated presidential candidate Hamdeen Sabahy demanded the referendum be deferred until a consensus could be reached on a new draft, saying there could be "no dialogue while blood is being spilled in the streets".

But Muslim Brotherhood spokesman Mahmoud Ghozlan said scrapping Mursi's decree had removed any cause for controversy.

"We ask others to announce their acceptance of the referendum result," he said on the group's Facebook page, asking whether the opposition would accept "the basics of democracy".

"NOT LOGICAL"

More protests were planned near Mursi's palace, despite tanks, barbed wire and other barriers installed last week after clashes between Islamists and their rivals killed seven people.

"A constitution without consensus can't go to a referendum," said Hermes Fawzi, 28, a protester outside the palace. "It's not logical that just one part of society makes the constitution."

After the dialogue hosted by Mursi, a spokesman announced that the president had issued a new decree whose first article "cancels the constitutional declaration" of November 22. He said the referendum could not be delayed for legal reasons.

Egypt is torn between Islamists, who were suppressed for decades, and their rivals, who fear religious conservatives want to squeeze out other voices and restrict social freedoms. Many Egyptians just crave stability and economic recovery.

Each side has mobilized tens of thousands of supporters in rival rallies in Cairo and other cities. Mursi's foes have chanted for his downfall. Islamists fear a plot to oust the most populous Arab nation's first freely elected president.

Islamists reckon they can win the referendum and, once the new constitution is in place, an election for a new parliament about two months later. The Islamist-led lower house elected this year was dissolved after a few months by a court order.

Investors appeared relieved at Mursi's retraction of his decree, sending Egyptian stocks 4.4 percent higher on Sunday. Markets are awaiting approval of a $4.8 billion IMF loan later this month designed to support the budget and economic reforms.

The new decree removed some parts of the old one that had angered the opposition, including an article that had given Mursi broad powers to confront threats to the revolution or the nation - wording that critics said gave him arbitrary authority.

It also dropped an article that had shielded Mursi's actions from the courts until a new parliament was elected, reflecting his distrust of a judiciary largely unreformed from Mubarak's era. But the new decree said "constitutional declarations including this declaration" remained beyond judicial review.

The new decree also set procedures to form an assembly to write a new constitution if Egyptians vote this draft down.

The military, which led Egypt's transition for 16 turbulent months after Mubarak fell, told feuding factions on Saturday that only dialogue could avert "catastrophe". But a military source said these remarks did not herald an army takeover.

(Additional reporting by Tamim Elyan and Yasmine Saleh; Writing by Alistair Lyon; Editing by Mark Heinrich)

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Egyptian military urges dialogue to avert "catastrophe"

CAIRO (Reuters) - Egypt's military said on Saturday only dialogue could avert "catastrophe", stepping into a crisis pitting an Islamist president against opponents of his drive to reshape a nation in turmoil since Hosni Mubarak's overthrow.

An army statement, which state radio and television interrupted their programs to read out, told feuding factions that a solution to the upheaval in the most populous Arab nation should not contradict "legitimacy and the rules of democracy".

That sounded like a swipe at protesters who have besieged the palace of freely elected President Mohamed Mursi and who have called for his removal, going beyond mainstream opposition demands for him to retract a decree that expanded his powers.

The statement also called for a "serious" national dialogue - perhaps one more credible than talks convened by Mursi on Saturday in the absence of opposition leaders. They insist he must first scrap his November 22 decree, defer next week's popular vote on a new constitution and allow the text to be revised.

Deep rifts have emerged over the destiny of a country of 83 million where Mubarak's ouster after 30 years of autocratic rule led to a messy army-led transition, with the Muslim Brotherhood and its allies winning two elections. Many Egyptians crave a return to stability and economic recovery.

The spokesman for the main Islamist coalition demanded that the referendum go ahead on time on the constitution drafted by an Islamist-led assembly from which liberals had walked out.

The army, which ran Egypt for months after Mubarak fell in February 2011, again cast itself primarily as the neutral guarantor of the nation and a military source said there was no plan to retake control of the country or its turbulent streets.

"DARK TUNNEL"

"The armed forces affirm that dialogue is the best and only way to reach consensus," the statement said. "The opposite of that will bring us to a dark tunnel that will result in catastrophe and that is something we will not allow."

The military, however, did seem poised to take a more active role in security arrangements for the December 15 referendum.

A cabinet source said the cabinet had discussed reviving the army's ability to make arrests if it were called upon to back up police, who normally provide security for elections.

Mursi's office said the "national dialogue", chaired by the president, had begun with about 40 political and other public figures discussing "means to reach a solution to differences over the referendum...and the constitutional decree".

The instability in Egypt worries the West, especially the United States, which has given Cairo billions of dollars in military and other aid since it made peace with Israel in 1979.

The army issued its statement while protesters were still camped out by the gates of the presidential palace.

The tens of thousands of Mursi foes who surged past tanks and barbed wire to reach the palace gates on Friday night had dispersed. But a hard core stayed overnight in a score of tents.

Some had spray-painted "Down with Mursi" on tanks of the elite Republican Guard posted there after clashes between rival groups killed at least seven people and wounded 350 this week.

Others draped the tanks with posters of Mursi and the word "Leave" scored across his face in red letters.

"We are no longer calling for scrapping the decree and delaying the referendum," Samir Fayez, a Christian protester at the palace, said. "We have one demand in five letters: leave."

Nearby, a Mursi supporter named Mohamed Hassan was quietly observing the scene. He suggested that the Muslim Brotherhood and its ultra-orthodox Salafi Islamist allies could easily overwhelm their foes if they chose to mobilize their base.

"The Brotherhood and Salafis by themselves are few but they have millions of supporters who are at home and haven't taken it to the streets yet," murmured the 40-year-old engineer.

"HATE US, BUT TALK"

The Muslim Brotherhood's supreme guide, Mohamed Badie, denounced opposition protests that have swirled around the walls of the Mursi's palace, saying they "ruin legitimacy".

Badie said eight people, all of them Brotherhood members, had been killed this week and urged the interior minister to explain why police had failed to prevent assailants from torching the organization's headquarters and 28 other offices.

"Get angry with the Brotherhood and hate us as much as you like, but be reasonable and preserve Egypt's unity," he told a news conference. "We hope everyone gets back to dialogue."

The well-organized Brotherhood, which thrust Mursi from obscurity to power, remains his surest source of support, with over 80 years of religious and political struggle behind it.

In the referendum, due to be followed by a parliamentary election, Islamist proponents of the constitution may benefit from the votes of millions of Egyptians desperate for the country to move on and revive its crippled economy.

A Brotherhood official welcomed the army's "balanced" line. Former Arab League chief Amr Moussa, now an opposition leader, said the army was reacting to an "enormously dangerous" crisis.

The military was the power behind all previous presidents and an army council temporarily took over after Mubarak's fall. However, Mursi pushed the generals aside in August and they had shown little appetite to intervene in Egypt's latest crisis.

(Additional reporting by Edmund Blair, Omar Fahmy and Yasmine Saleh; Writing by Alistair Lyon; Editing by Mark Heinrich)

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Egypt struggle seen costing Mursi, even if he wins

CAIRO (Reuters) - The crisis unleashed by President Mohamed Mursi's bid to wrap up Egypt's transition on his own terms has eroded his nation's faith in their nascent democracy and will complicate the already unenviable task of government.

His effort to drive through a constitution against the wishes of major sections of society, including a Christian minority, has damaged prospects for building consensus needed to tackle challenges ahead, such as fixing a broken economy.

Having promised to be a president for all, Mursi stands accused of putting the interests of his group, the Muslim Brotherhood, ahead of others who say their aspirations are not reflected in the draft to be put to a December 15 referendum.

On the other side, suspicions harbored by Islamists towards their secular-minded opponents have only deepened as a result of the turmoil ignited by Mursi's effort to fast-track the final stage of the transition from Hosni Mubarak's rule.

With the more extreme among them opposed to the very notion of democracy, the Islamists say their rivals are not respecting the rules of the game that put them in the driving seat by winning free and fair elections.

People anxious to see Egypt recover from two years of turbulence fear bad blood could persist and squash hopes for cooperation needed to help Mursi rule smoothly and deliver much-needed reforms.

"If they succeed in the referendum, they will see that as a step forward, but not without cost," said a Western diplomat.

Though Mursi won international praise for mediating a truce in Gaza, the violence on his own streets worries the West and particularly the United States, which has given Cairo billions of dollars in military and other aid since Egypt made peace with Israel in 1979. U.S. President Barack Obama told Mursi on Thursday of his "deep concern" about casualties during protests.

A victim of the polarization could be the Brotherhood's plans to forge electoral alliances with liberals in forthcoming parliamentary polls. The head of the Brotherhood's Freedom and Justice Party told Reuters this week he saw such alliances as preferable to an ideological tie-up with other Islamists.

The divisions are now playing out in the streets. Seven people were killed and hundreds wounded this week in clashes between Islamists and their rivals. A call by Mursi for dialogue was rebuffed by activists who are to protest again on Friday.

"We said that this state of polarization, if it was not dealt with properly, would reach this point, and it has," said Ayman Al-Sayyad, who quit his post as a Mursi adviser on Wednesday following an eruption of violence.

"This was the scene that we were trying to avoid," he added in an interview with al-Hayat television.

The inclusive image Mursi had tried to build around his administration was one of the first victims of the crisis that mushroomed following a November 22 decree that expanded his powers and protected his decisions from judicial review.

RESIGNATIONS

A Christian and a woman were among the first to resign from his staff, as surprised by the decree as most Egyptians. Despite an early bout of violence, Mursi showed no sign of wavering and appeared to brush off his critics.

"I see things more than they do," he told Time.

With speculation swirling around how he took the decision, Egyptians long suspicious of the Brotherhood have concluded Mursi is running the country at the group's command.

In response, the Islamists complain that many of Mursi's attempts at outreach were rebuffed early on. Their view of the opposition has grown dimmer through the crisis. Brotherhood members have started to dismiss opponents as "feloul", meaning "remnants" - a pejorative implying loyalty to Mubarak.

"The really unfortunate side effect of the last two weeks is the political atmosphere has become really toxic. I fear that could endure long past the current crisis," said Elijah Zarwan, a fellow with the European Council on Foreign Relations.

"The next government is going to have to move very quickly to address many problems and it will need cooperation. In the current atmosphere, it is hard to imagine others cooperating."

Such cooperation will be at a premium for introducing policies aimed at reining in a crushing budget deficit and staving off a balance of payments crisis. Egypt's economy has lost $70 billion to $80 billion of economic output since Mubarak was ousted, in one economist's estimate.

Top of the economic to-do list are measures to cut back on fuel subsidies - one of the biggest drains on state finances. Tweaks to such support are bound to be unpopular in a nation where both rich and poor have grown used to cheap petrol.

"He has inherited an economy that is weak and needs serious surgery, so he is going to have to make controversial decisions over the next year or so," said Simon Kitchen, strategist at EFG-Hermes, an Egyptian investment bank.

"Ideally you want to do that in an environment where you have some sort of political consensus," he said.

"THEY BURNED THEIR BRIDGES"

Some subsidy reform and other steps to cut waste are part of a program agreed in principle with the International Monetary Fund for $4.8 billion loan designed to support the budget.

The IMF board meets on December 19 to discuss approval of the loan, which would be seen by investors as a seal of approval for the government's reform program.

Besides the economy, Mursi needs wider backing to tackle other problems including a judiciary which his opponents agree needs overhaul. But even when he sacked the unpopular, Mubarak-era prosecutor general, Mursi was criticized for showing an autocratic streak in the way he went about it.

In the new system of government outlined in the draft constitution, Egypt's next parliament will have a say over the shape of government. A parliamentary election would go ahead some two months later if the constitution is approved in the referendum.

With that in mind, the Freedom and Justice Party is already eyeing alliances to fight the parliamentary election.

FJP leader Saad al-Katatni said in an interview his preference was for an alliance with liberals, not the hardline Islamists whose backing has helped Mursi through the crisis. "Our preferred option is that the alliance not be ideological so that we don't have a split in the nation," he said.

The Brotherhood had kept the nascent hardline Salafi parties at arm's length as they emerged after Mubarak's political demise. That trend has gradually been reversed as the Brotherhood has looked to fellow Islamists for support.

"They burned their bridges with the secular camp and relied heavily on the Salafi camp. We don't feel that is where they naturally want to be right now," said the Western diplomat, speaking on condition of anonymity.

Sentiment from liberal parties suggests the Brotherhood will struggle to convince liberals that it is a trustworthy partner.

"I don't think the man realizes the degree of rebellion and rage the people have," said Ahmed Said, head of the liberal Free Egyptians Party, referring to Mursi. "The country is totally divided and polarized. You have two nations now."

(Writing by Tom Perry; Editing by Peter Graff)

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Military halts clashes as political crisis grips Egypt

CAIRO (Reuters) - Egypt's Republican Guard restored order around the presidential palace on Thursday after fierce overnight clashes killed seven people, but passions ran high in a struggle over the country's future.

The Islamist president, Mohamed Mursi, criticized by his opponents for his silence in the last few days, was due to address the nation later in the day, state television said.

Hundreds of his supporters who had camped out near the palace overnight withdrew before a mid-afternoon deadline set by the Republican Guard. Dozens of Mursi's foes remained, but were kept away by a barbed wire barricade guarded by tanks.

The military played a big role in removing President Hosni Mubarak during last year's popular revolt, taking over to manage a transitional period, but had stayed out of the latest crisis.

Mursi's Islamist partisans fought opposition protesters well into the early hours during dueling demonstrations over the president's decree on November 22 to expand his powers to help him push through a mostly Islamist-drafted constitution.

Officials said seven people had been killed and 350 wounded in the violence, for which each side blamed the other. Six of the dead were Mursi supporters, the Muslim Brotherhood said.

The street clashes reflected a deep political divide in the most populous Arab nation, where contrasting visions of Islamists and their liberal rivals have complicated a struggle to embed democracy after Mubarak's 30-year autocracy.

The United States, worried about the stability of an Arab partner which has a peace deal with Israel and which receives $1.3 billion a year in U.S. military aid, has urged dialogue.

The commander of the Republican Guard said deployment of tanks and troop carriers around the presidential palace was intended to separate the adversaries, not to repress them.

"The armed forces, and at the forefront of them the Republican Guard, will not be used as a tool to oppress the demonstrators," General Mohamed Zaki told the state news agency.

Hussein Abdel Ghani, spokesman of the opposition National Salvation Front, said more protests were planned, but not necessarily at the palace in Cairo's Heliopolis district.

"Our youth are leading us today and we decided to agree to whatever they want to do," he told Reuters.

UNITY APPEAL

Egypt plunged into renewed turmoil after Mursi issued his November 22 decree and an Islamist-dominated assembly hastily approved a new constitution to go to a referendum on December 15.

The Supreme Guide of the Brotherhood, to which Mursi belonged before he was narrowly elected president in June, appealed for unity. Divisions among Egyptians "only serve the nation's enemies", Mohamed Badie said in a statement.

Rival factions used rocks, petrol bombs and guns in the clashes around the presidential palace.

"We came here to support President Mursi and his decisions. He is the elected president of Egypt," said demonstrator Emad Abou Salem, 40. "He has legitimacy and nobody else does."

Opposition protester Ehab Nasser el-Din, 21, his head bandaged after being hit by a rock the day before, decried the Muslim Brotherhood's "grip on the country", which he said would only tighten if the new constitution is passed.

Another protester, Ahmed Abdel-Hakim, 23, accused the Brotherhood of "igniting the country in the name of religion".

Mursi's opponents accuse him of seeking to create a new "dictatorship". The president says his actions were necessary to prevent courts still full of judges appointed by Mubarak from derailing a constitution vital for Egypt's political transition.

Mursi has shown no sign of buckling under pressure from protesters, confident that the Islamists, who have dominated both elections since Mubarak was overthrown, can win the referendum and the parliamentary election to follow.

Mahmoud Hussein, the Brotherhood's secretary-general, said holding the plebiscite was the only way out of the crisis, dismissing the opposition as "remnants of the (Mubarak) regime, thugs and people working for foreign agendas".

As well as relying on his Brotherhood power base, Mursi may also tap into a popular yearning for stability and economic revival after almost two years of political turmoil.

The Egyptian pound sank on Thursday to its lowest level in eight years, after previously firming on hopes that a $4.8 billion IMF loan would stabilize the economy. The Egyptian stock market fell 4.4 percent after it opened.

Foreign exchange reserves fell by nearly $450 million to $15 billion in November, indicating that the Central Bank was still spending heavily to bolster the pound. The reserves stood at about $36 billion before the anti-Mubarak uprising.

(Additional reporting by Tom Perry and Yasmine Saleh; Writing by Alistair Lyon; Editing by Giles Elgood)

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Confrontation between rival protesters looms in Egypt crisis

CAIRO (Reuters) - Egypt's Muslim Brotherhood called for a rally backing President Mohamed Mursi outside his palace on Wednesday and leftists planned a counter-demonstration, raising fears of clashes in a crisis over a disputed push for a new constitution.

Mursi returned to work at his compound a day after it came under siege from opposition protesters furious at his drive to ratify a new constitution in a snap referendum set for December 15 after temporarily expanding his powers by decree.

The Islamist president said he acted to prevent courts still full of appointees from the era of autocratic predecessor Hosni Mubarak from derailing the draft constitution meant to complete a political transition in the Arab world's most populous state.

The Brotherhood, from which Mursi emerged to narrowly win a free election in June, summoned supporters to a demonstration outside the palace in response to what it termed "oppressive abuses" by opposition parties.

Brotherhood spokesman Mahmoud Ghozlan was quoted on its Facebook page as saying opposition groups "imagined they could shake legitimacy or impose their views by force".

Leftist opposition leader Hamdeen Sabahy promptly urged his supporters to go to the streets as well, heightening the chances of confrontation between Islamists and their opponents.

A spokeswoman for Sabahy's Popular Current movement asked protesters to head to the palace to reinforce those still camped out there after Tuesday evening's protests, in which officials said 35 protesters and 40 police were wounded.

Although they fired tear gas when protesters broke through barricades to reach the palace walls, riot police appeared to handle those disturbances with restraint.

About 200 protesters camped out overnight, blocking one gate to the palace in northern Cairo, but traffic was flowing normally and riot police had been withdrawn.

"Our demands to the president: retract the presidential decree and cancel the referendum on the constitution," read a placard hung by demonstrators on a palace gate.

The rest of the Egyptian capital was calm, despite the political furor over Mursi's November 22 decree handing himself wide powers and shielding his decisions from judicial oversight.

Crowds had gathered on Tuesday for what organizers dubbed a "last warning" to Mursi. "The people want the downfall of the regime," they chanted, roaring the signature slogan of last year's uprising that ousted Mubarak.

But the "last warning" may turn out to be one of the last gasps for a disparate opposition that has little chance of stopping next week's vote on a constitution drafted over six months and swiftly approved by an Islamist-dominated assembly.

MURSI STANDS HIS GROUND

Facing the gravest crisis of his six-month-old tenure, the Islamist president has shown no sign of buckling under pressure, confident that the Muslim Brotherhood and its Islamist allies can win the referendum and a parliamentary election to follow.

Many Egyptians yearn for an end to political upheaval that has scared off investors and tourists, damaging the economy.

Ahmed Kamel, spokesman for the Congress Party led by former Arab League chief Amr Moussa, said Mursi should meet opposition demands, not call for an Islamist counter-demonstration.

Some protesters have already gone beyond opposition calls for Mursi to scrap his decree, defer the referendum and set up a "representative committee" to revise the draft constitution, instead demanding the president's overthrow.

"The demands of the street are moving faster than those of the politicians," said Elijah Zarwan, a fellow with the European Council on Foreign Relations. "Now is the time for the Egyptian liberals to negotiate without conditions."

COURT PROTEST

Dozens of pro-Mursi demonstrators, watched by equal numbers of police, waved flags outside the Supreme Constitutional Court, whose rulings have complicated the Islamists' rise to power.

"You are not a political agency," read one banner held by the demonstrators, addressing a court that in June ordered the dissolution of the Islamist-led lower house of parliament.

Mursi issued his decree temporarily putting his actions above the law to forestall any court ruling to dissolve the upper house or the assembly that wrote the constitution.

State institutions, with the partial exception of the judiciary, have mostly fallen in behind Mursi.

The army, the power behind all previous Egyptian presidents in the republic's six-decade history, has gone back to barracks, having apparently lost its appetite to intervene in politics.

In a bold move, Mursi sacked Mohamed Hussein Tantawi, the Mubarak-era army commander and defense minister, in August and removed the sweeping powers that the military council which took over after Mubarak's fall had grabbed two months earlier.

The liberals, leftists, Christians, ex-Mubarak followers and others opposed to Mursi, elected in a close result against a secular rival, have yet to generate a mass movement or a grassroots political base to challenge the Brotherhood.

Protesters have scrawled "leave" over Mursi's palace walls, but the president has made clear he is not going anywhere.

"The crisis we have suffered for two weeks is on its way to an end, and very soon, God willing," Saad al-Katatni, head of the Brotherhood's Freedom and Justice Party, told Reuters.

Investors have seized on hopes that Egypt's turbulent transition, which has buffeted the economy for two years, may soon head for calmer waters, sending stocks 1.6 per cent higher after a 3.5 percent rally on Tuesday.

The most populous Arab nation has turned to the IMF for a $4.8 billion loan to help it out of a crisis that has depleted its foreign currency reserves.

The government said on Wednesday the process was on track and Egypt's request would go to the IMF board as expected.

(Additional reporting by Tom Perry and Yasmine Saleh; Writing by Alistair Lyon; Editing by Mark Heinrich)

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NATO warns Syria not to use chemical weapons

BEIRUT (Reuters) - NATO told Syrian President Bashar al-Assad on Tuesday that any use of chemical weapons in his fight against encroaching rebel forces would be met by an immediate international response.

The warning from NATO Secretary-General Anders Fogh Rasmussen came as Syrian forces bombarded rebel districts near Damascus in a sustained counter-attack to stem rebel gains around Assad's power base.

Syrian state media said a rebel mortar attack on a school had killed 28 students and a teacher.

International concern over Syria's intentions has been heightened by reports that its chemical weapons have been moved and could be prepared for use.

"The possible use of chemical weapons would be completely unacceptable for the whole international community and if anybody resorts to these terrible weapons I would expect an immediate reaction from the international community," Rasmussen told reporters at the start of a meeting of alliance foreign ministers in Brussels.

The chemical threat made it urgent for the alliance to send Patriot anti-missile missiles to Turkey, Rasmussen said.

The French Foreign Ministry referred to "possible movements on military bases storing chemical weapons in Syria" and said the international community would react if the weapons were used.

U.S. President Barack Obama on Monday told Assad not to use chemical weapons, without saying how the United States might respond. The Foreign Ministry in Damascus said it would never use such weapons against Syrians.

Western military experts say Syria has four suspected chemical weapons sites, and it can produce chemical weapons agents including mustard gas and sarin, and possibly also VX nerve agent. The CIA has estimated that Syria possesses several hundred liters of chemical weapons and produces hundreds of tonnes of agents annually.

FLIGHTS SUSPENDED

The fighting around Damascus has led foreign airlines to suspend flights and prompted the United Nations and European Union to reduce their presence in the capital, adding to a sense that the fight is closing in.

The army fightback came a day after the Syrian foreign ministry spokesman was reported to have defected in a potentially embarrassing blow to the government.

The Syrian Observatory for Human Rights said 200 people were killed across Syria on Monday, more than 60 of them around Damascus. Assad's forces bombarded districts to the south-east of the capital on Tuesday, near to the international airport, and in the rebel bastion of Daraya to the south-west.

Opposition footage posted on the Internet showed a multiple rocket launcher fire 20 rockets, which activists said was filmed at the Mezze military airport in Damascus.

Reuters could not independently verify the footage due to the government's severe reporting restrictions.

In central Damascus, shielded for many months from the full force of a civil war in which 40,000 people have been killed, one resident reported hearing several loud explosions.

"I have heard four or five thunderous blows. It could be barrel bombs," she said, referring to makeshift bombs which activists say Assad's forces have dropped from helicopters on rebel-dominated areas.

The state news agency said that 28 students and a teacher were killed near the capital when rebels fired a mortar bomb on a school. Rebels have targeted government-held residential districts of the capital.

The mainly Sunni Muslim rebel forces have made advances in recent weeks, seizing military bases, including some close to Damascus, from forces loyal to Assad, who is from Syria's Alawite minority linked to Shi'ite Islam.

Faced with creeping rebel gains across the north and east of the country, and the growing challenge around the capital, Assad has increasingly resorted to air strikes against the insurgents.

A diplomat in the Middle East said Syrian Foreign Ministry spokesman Jihad Makdissi had left the country and defected, while the British-based Observatory said it had information that he flew from Beirut on Monday afternoon heading for London.

In Beirut, a diplomat said Lebanese officials had confirmed that Makdissi spent several days in Beirut before leaving on Monday, but could not confirm his destination.

"We're aware of reports that he has defected and may be coming to the UK. We're seeking clarification," a Foreign Office spokeswoman in London said.

Makdissi was the public face to the outside world of Assad's government as it battled the 20-month-old uprising. But he had barely appeared in public for several weeks before Monday's report of his defection.

He had little influence in a system largely run by the security apparatus and the military. But Assad's opponents will see the loss of such a high profile figure, if confirmed, as further evidence of a system crumbling from within.

ESCALATED VIOLENCE

The United Nations and European Union both said they were reducing their presence in Syria in response to the escalated violence around the capital.

A spokesman for U.N. humanitarian operations said the move would not stop aid deliveries to areas which remained accessible to relief convoys.

"U.N.-funded aid supplies delivered through SARC (Syrian Arab Red Crescent) and other charities are still moving daily where the roads are open," Jens Laerke told Reuters in Geneva.

"We have not suspended our operation, we are reducing the non-essential international staff."

Three remaining international staff at the European Union delegation, who stayed on in Damascus after the departure of most Western envoys, crossed the border into Lebanon on Tuesday after pulling out of the Syrian capital.

The Syrian army appears to have focused most of its energy on Damascus, where rebels have been planning to push into the capital from the surrounding suburbs.

Neither side appears to have the upper hand in the fighting and a previous attempt by rebels last July to hold ground in the city was crushed as the fighters fell back into the suburbs and nearby countryside.

Clashes have continued around Damascus International Airport and along the airport highway, which has become an on-and-off battleground that forced foreign airlines to suspend flights to Damascus since Thursday evening.

(Additional reporting by David Brunnstrom in Brussels, Khaled Yacoub Oweis in Cairo, Erika Solomon, Oliver Holmes and Ayat Basma in Beirut, Mohammed Abbas and David Cutler in London, and Stephanie Nebehay in Geneva)

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Israel faces European backlash over settlement plan

JERUSALEM (Reuters) - Israel faced concerted criticism from Europe on Monday over Prime Minister Benjamin Netanyahu's decision to expand settlement building after the United Nations' de facto recognition of Palestinian statehood.

Britain, France and Sweden summoned the Israeli ambassadors in their respective capitals to hear deep disapproval of the plan to erect 3,000 more homes in the occupied West Bank and East Jerusalem.

Ahead of a Netanyahu visit this week, Germany, considered Israel's closest ally in Europe, urged it to refrain from expanding settlements, and Russia said it viewed the Israeli moves with serious concern.

Angered by the U.N. General Assembly's upgrading on Thursday of the Palestinians' status in the world body from "observer entity" to "non-member state", Israel said the next day it would build the new dwellings for settlers.

Such projects in the past, on land Israel captured in a 1967 war and which Palestinians seek for a future state, have routinely drawn almost pro forma world condemnation.

But in a dramatic shift that Netanyahu would have certainly realized would raise the alarm among Palestinians and in world capitals, his pro-settler government also ordered "preliminary zoning and planning work" for thousands of housing units in areas including the so-called "E1" zone east of Jerusalem.

Such construction in the barren hills of E1 - still on the drawing board and never put into motion in the face of opposition from its main ally, the United States - could bisect the West Bank, cut off Palestinians from Jerusalem and further dim their hopes for a contiguous state.

The settlement plan, U.N. Secretary-General Ban Ki-moon said, would deal "an almost fatal blow" to a two-state solution to the Israeli-Palestinian conflict.

Britain made clear it would not support strong Israeli retaliation over the U.N. vote, which Palestinians sought after peace talks collapsed in 2010 in a dispute over settlement building.

"We deplore the recent Israeli decision to build 3,000 new housing units and unfreeze development in the E1 block," a Foreign Office spokesman said. "We have called on the Israeli government to reverse the decision."

But a spokesman for British Prime Minister David Cameron played down talk of recalling Britain's ambassador in Tel Aviv.

"We are not proposing to do anything further at this stage," the spokesman said. "We are continuing to have conversations with the Israeli government and others."

France expressed "serious concerns" to the Israeli ambassador, reminding him that settlement building in occupied territories was illegal and an "obstacle" to reviving peace talks with the Palestinians.

A French Foreign Ministry official, responding to reports Paris might bring its Tel Aviv envoy home, said: "There are other ways in which we can express our disapproval."

RETALIATION

Israeli Finance Minister Yuval Steinitz said Israel could not have remained indifferent to the Palestinians' unilateral move at the United Nations.

In Europe only the Czech Republic voted against the resolution while many countries, including France, backed it. Netanyahu also plans to visit Prague this week to express his thanks.

"I want to tell you that those same Europeans and Americans who are now telling us 'naughty, naughty over our response, understand full-well that we have to respond, and they themselves warned the Palestinian Authority," Steinitz told Army Radio.

Palestinian chief negotiator Saeb Erekat said building in E1 "destroys the two-state solution, (establishing) East Jerusalem as the capital of Palestine and practically ends the peace process and any opportunity to talk about negotiations in the future".

Sami Abu Zuhri, spokesman for the Hamas Islamist movement that governs the Gaza Strip, said the settlement plans were "an insult to the international community, which should bear responsibility for Israeli violations and attacks on Palestinians".

Only three weeks ago, Netanyahu won strong European and U.S. support for an offensive in the Hamas Islamist-run Gaza Strip, which Israel said was aimed at curbing cross-border rocket fire.

Favored by opinion polls to win a January 22 national election, he brushed off world condemnation of his latest settlement plans and complaints from critics at home that he is deepening Israel's diplomatic isolation.

He told his cabinet on Sunday that his government "will carry on building in Jerusalem and in all the places on the map of Israel's strategic interests".

But while his housing minister has said the government would soon invite bids from contractors to build 1,000 homes for Israelis in East Jerusalem and more than 1,000 in West Bank settlement blocs, the E1 plan was still in its planning stages.

"No one will build until it is clear what will be done there," the minister, Ariel Attias, said on Sunday.

Israel froze much of its activities in E1 under pressure from former U.S. President George W. Bush and the area has been under the scrutiny of his successor Barack Obama.

Most world powers consider Israel's settlements to be illegal. Israel cites historical and Biblical links to the West Bank and Jerusalem and regards all of the holy city as its capital, a claim that is not recognized internationally.

Approximately 500,000 Israelis and 2.5 million Palestinians live in the West Bank and East Jerusalem.

(Additional reporting by Crispian Balmer, Dan Williams, Nidal al-Mughrabi in Gaza, Jihan Abdalla in Ramallah, Sreve Gutterman in Moscow, Gareth Jones in Berlin, John Irish in Paris and Tim Castle in London; Writing by Jeffrey Heller; Editing by Giles Elgood)

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