Vietnam condemns China's sea claims as "serious violation"

HANOI/NEW DELHI (Reuters) - Vietnam condemned on Tuesday China's claims to disputed South China Sea islands as a serious violation of its sovereignty after saying it was setting up patrols to protect its fisheries and accusing Chinese boats of sabotage.

The condemnation of China's claims to the sea and its numerous reefs and tiny islands was the strongest yet from Vietnam since tension flared this year and came after India declared itself ready to send navy ships to safeguard its interests in the disputed waters.

Claims by an increasingly powerful China over most of the South China Sea have set it directly against U.S. allies Vietnam and the Philippines, while Brunei, Taiwan and Malaysia also claim parts of the mineral-rich waters.

Vietnam's condemnation came a day after its state oil and gas company, Petrovietnam, accused Chinese boats of sabotaging an exploration operation by cutting a seismic cable being towed behind a Vietnamese boat.

Vietnam's Foreign Ministry spokesman condemned the cable cutting as well as some recent Chinese provincial regulations that identified the disputed Spratly and Paracel islands as Chinese, and a map that did the same thing.

"The actions of the Chinese side have seriously violated Vietnam's sovereignty over the two archipelagos," the spokesman, Luong Thanh Nghi, said in a statement.

Vietnamese Foreign Ministry officials met representatives of the Chinese embassy in Hanoi on Monday, Nghi said.

The Vietnamese officials handed over a diplomatic note "resolutely opposing the above mentioned actions by the Chinese side, asking China to respect Vietnam's sovereignty, to immediately stop such wrongful acts and not to repeat similar actions."

Earlier, Vietnam said civilian-led patrols, backed by marine police and a border force, would be deployed from January 25 to stop foreign vessels violating fishing laws in Vietnam's waters.

A decree on the Vietnamese patrols was signed on November 29, the day Chinese media announced new rules authorizing police in the southern Chinese province of Hainan to board and seize foreign ships in the South China Sea.

"It's going to lead to friction," Carl Thayer, a Southeast Asia security expert at the University of New South Wales in Australia, said of China's new rules that take effect from January 1 on boarding ships which "illegally enter" waters it claims.

"If it begins to assert these rights and isn't challenged, over time it becomes customary, it becomes practice."

On Monday, Petrovietnam said the seismic vessel had been operating outside the Gulf of Tonkin when the cable was severed on Friday. It had earlier been surveying the Nam Con Son basin further south - an area where Indian state-run explorer Oil and Natural Gas Corp (ONGC) has a stake in a Vietnamese gas field.

Petrovietnam posted on its website comments by the deputy head of exploration, Pham Viet Dung, in which he said the cable was repaired and the survey resumed the following day.

"The blatant violation of Vietnamese waters by Chinese fishing vessels not only violates the sovereignty ... of Vietnam but also interferes in the normal operations of Vietnamese fishermen and affects the maritime activities of Petrovietnam," Dung was quoted as saying.

Asked about the complaint, Chinese Foreign Ministry spokesman Hong Lei told a briefing in Beijing that China was checking the reports of the incident, which he said was understood to have taken place in an area of overlapping claims.

"Chinese fishing boats were operating in normal fishing activities," Hong said.

COLLISION COURSE?

India has also declared itself ready to deploy naval vessels to the South China Sea to protect its oil-exploration interests there, a new source of tension in a disputed area where fears of conflict have been growing steadily.

Indian navy chief, Admiral D.K Joshi, said on Monday that, while India was not a territorial claimant in the South China Sea, it was prepared to act, if necessary, to protect its maritime and economic interests in the region.

"When the requirement is there, for example, in situations where our country's interests are involved, for example ONGC ... we will be required to go there and we are prepared for that," Joshi told a news conference.

"Now, are we preparing for it? Are we having exercises of that nature? The short answer is yes," he said.

An Indian government spokesman on Tuesday played down the comments: "This is an issue for the parties concerned to resolve."

India is not the only non-claimant nation concerned about disruption to shipping or oil exploration in the South China Sea. The United States, a close ally to several of the Southeast Asian claimants, has also voiced concern at the prospect of China stopping international ships in contested waters.

India has sparred diplomatically with China in the past over its gas and oil exploration block off the coast of Vietnam.

Any display of naval assertiveness by India in the South China Sea would likely fuel concern that the navies of the two rapidly growing Asian giants could be on a collision course as they seek to protect trade routes and lock in the supply of coal, minerals and other raw material from foreign sources.

Joshi described the modernization of China's navy as "truly impressive" and a source of major concern for India.

Asked what China would do if Indian navy entered the South China Sea to protect its oil interests, the Chinese Foreign Ministry spokesman, Hong, said China had "indisputable sovereignty" over the sea's islands and surrounding waters.

"China opposes unilateral oil and gas development in disputed waters of the South China Sea. We hope that concerned countries respect China's position and rights, and respect efforts made through bilateral talks to resolve disputes."

Singapore, home to the world's second-busiest container port, joined the Philippines on Monday in expressing concern at the prospect of Chinese police boarding ships. The Philippines on Saturday condemned the Chinese plan as illegal.

Estimates for proven and undiscovered oil reserves in the South China Sea range as high as 213 billion barrels of oil, the U.S. Energy Information Administration said in a 2008 report. That would surpass the proven oil reserves of every country except Saudi Arabia and Venezuela, according to the BP Statistical Review.

On Monday, China's National Energy Administration said China aims to produce 15 billion cubic meters of natural gas a year from the South China Sea by 2015.

It said the sea would "form the main part" of China's offshore gas exploration plans.

(Reporting by Arup Roychoudhury and Mayank Bhardwaj in NEW DELHI, Kevin Lim in SINGAPORE, Ho Binh Minh in HANOI, Paul Carsten in Bangkok and Ben Blanchard in Beijing; Editing by Jason Szep and Robert Birsel)

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Netanyahu's Israeli settlement push could be ballot box boon

JERUSALEM (Reuters) - For Benjamin Netanyahu, plans to expand Israeli settlements may risk a diplomatic crisis with Europe but could prove a good bet at the ballot box.

With a January 22 election looming, the Israeli leader has defied long-standing international opposition to settlements and announced plans to build at least 3,000 more homes in the occupied West Bank and East Jerusalem after the United Nations' de facto recognition of Palestinian statehood.

Standing up to Europe, where a string of Israeli diplomats were summoned for reprimands by the governments of Britain, France, Spain, Sweden and Denmark on Monday, could help cement right-wing voter support for the conservative prime minister.

"We feared that politicians would clamber over themselves to show who could be tougher with the Palestinians. However we had hoped that Netanyahu would show more restraint. It didn't happen," said a Western diplomat in Jerusalem.

"We did not want the Palestinians to go to the United Nations during an Israeli election campaign precisely for this reason," the diplomat said.

Israel rebuffed European protests and appeals to reverse course on the settlement drive, saying it would "stand by its vital interests, even in the face of international pressure".

Settlement projects on land Israel captured in the 1967 Arab-Israeli War are considered illegal by most world powers and have routinely drawn condemnation from them. Some 500,000 Israelis and 2.5 million Palestinians live in the West Bank and East Jerusalem.

But this time, the government also ordered new "planning work" in one of the most highly sensitive areas of the West Bank known as "E1". Israeli housing on its barren hills could split the West Bank in two, denying the Palestinians a viable state.

Many Israelis have traditionally viewed the United Nations and many European governments as being particularly sympathetic to the Palestinian cause.

And in an aside by Netanyahu during a visit to the United States, Israel's main ally, he appeared to indicate he shared those sentiments.

"Americans get it," he said, referring to arguments he has made in support of his government's policies. "Europeans don't."

That has not always been the case as far as U.S. President Barack Obama is concerned, particularly on the settlement issue and the open question of whether Israel might attack Iran's nuclear program in defiance of Washington's calls to give diplomatic options more time.

But Obama has never been at the top of Israelis' popularity lists and friction between the two leaders seems not to have hurt Netanyahu in the opinion polls, which predict he will coast to victory in the upcoming ballot.

VOTER EXPECTATIONS

Tamir Sheafer, a political scientist at Jerusalem's Hebrew University, said Netanyahu's settlement move was "what his voters expect of him" and stemmed from internal political considerations.

"Maybe they are worried in (Netanyahu's) Likud that right-wing voters will opt instead for (the far-right religious)Habayit Hayehudi party," Sheafer said.

So far, European anger over the settlement plan has not led to any sanctions against Israel. Any punitive measures before the election would fuel arguments made by Netanyahu's political opponents that he was deepening its diplomatic isolation.

"I think there are electoral considerations (behind Netanyahu's settlement moves)," said Gideon Rahat, a Hebrew University political scientist. "But he's also used to (Europe and the United States) not bothering him much and now they seem to have changed the rules of the game."

Still, Sheafer said, "something very unusual or unexpected would have to happen for the next government not to be headed by Netanyahu - it's very simple mathematics, the center-left simply doesn't have enough parliamentary seats" to form a coalition.

With details of the future settler housing in the West Bank and East Jerusalem still sketchy and Israeli officials saying any construction in E1 would be more than a year away, Israel and Europe still have room to maneuver.

"We don't know where these units will be built. I don't think anyone knows. They are probably scurrying around now trying to figure out where they will be built," said Daniel Seidemann, an Israeli expert on settlements.

"This announcement was made for dramatic effect. That doesn't mean it won't happen, it means the dramatic effect precedes the decision," Seidemann said.

Tzipi Livni, a former foreign minister who is running in the upcoming poll as the head of a new centrist party, said in a statement that Netanyahu's settlement move "isolates Israel and encourages international pressure".

But she also appeared to suggest that Netanyahu might be bluffing.

"In any case (the construction) won't happen," she said.

(Additional reporting by Crispian Balmer and Allyn Fisher-Ilan; Writing by Jeffrey Heller; Editing by Andrew Osborn)

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U.S. court hearing set in Strauss-Kahn civil lawsuit

NEW YORK (Reuters) - Former International Monetary Fund head Dominique Strauss-Kahn and the hotel maid who accused him of sexual assault will appear in New York state court next week to brief a judge on the status of settlement talks in the maid's civil case against him.

The setting of the court date comes just days after a source familiar with the matter said the two sides had reached a preliminary agreement to settle the case.

"The parties have been directed to appear before me on December 10 to report on the status of settlement discussions," Justice Douglas McKeon, the Bronx County Supreme Court judge overseeing the case, said on Tuesday. "If the case settles, this will be announced in open court on that date."

Strauss-Kahn's lawyers in the United States and France have acknowledged that a deal was under discussion but said last week that no settlement had been reached. They denied a report that the 63-year-old had agreed to pay the maid, Nafissatou Diallo, $6 million to end the lawsuit.

A source familiar with the case said the amount of any settlement would likely be the subject of a confidentiality agreement.

The scheduling of the status conference, however, may signal that a final deal has been reached. Lawyers for both Strauss-Kahn and Diallo did not immediately respond to requests for comment on Tuesday morning.

Diallo accused Strauss-Kahn of attacking her in his luxury hotel room in Manhattan on May 14, 2011. The allegations led to Strauss-Kahn's arrest, forced his resignation from the IMF and destroyed his status as a frontrunner for the French presidency.

The criminal charges were dropped in August 2011 after New York prosecutors developed doubts about Diallo's credibility. Diallo filed the civil lawsuit against Strauss-Kahn a few weeks before the case was dismissed.

Strauss-Kahn, who has said that the encounter with Diallo was a "moral error" but was entirely consensual, filed a countersuit against her, claiming defamation.

Even as the U.S. case appears close to an end, Strauss-Kahn is awaiting a decision by a French court on December 19 on whether to call off an investigation involving parties in Lille attended by prostitutes, where he risks trial on a charge of "aggravated pimping.

In recent months, Strauss-Kahn has been making an under-the-radar comeback with a handful of speaking engagements at private conferences and by setting up a business consultancy firm in Paris.

If the Lille case is dropped and Diallo ends her civil lawsuit, Strauss-Kahn would be freer to pursue his consultancy work and could even consider a return to public life in France, where he has been shunned since the Diallo scandal.

(Editing by Dan Burns and Jackie Frank)

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Sunni-Alawite clashes break out in Lebanon's Tripoli

TRIPOLI, Lebanon (Reuters) - Two men were killed and 12 wounded in sectarian clashes in the Lebanese port city of Tripoli on Tuesday between gunmen loyal to opposing sides in neighboring Syria's civil war, residents said.

The army cut off all roads leading to the area on Tuesday evening as militants launched rocket-propelled grenades at each other along Syria Street, a main thoroughfare that has become synonymous with fighting over the past year.

Tensions had been building since the deaths of at least 14 Lebanese and Palestinian gunmen from north Lebanon in a Syrian town close to the border. They appeared to have joined insurgents waging a 20-month-old revolt against Syrian President Bashar al-Assad.

Syrian state television has shown graphic footage of the dead men, riddled with gunshot wounds and lying in the grass.

Lebanon's Foreign Minister Adnan Mansour asked the Syrian ambassador to hand over the bodies of the men after their families protested in Tripoli to demand the Lebanese government return the dead and determine the whereabouts of the missing.

Tripoli's sectarian divisions have made it a flashpoint within Lebanon where violence from Syria has sometimes spilled over. The Syrian uprising is mostly being waged by Sunni Muslims and largely opposed by minorities like Assad's own Alawite sect.

Tripoli is a majority Sunni city and mostly supports the uprising next door, but the coastal city has an Alawite minority and clashes have erupted several times since the revolt began.

Residents said violence flared overnight when rocket-propelled grenades were fired by gunmen in the Sunni neighborhood of Bab al-Tabbaneh and the Alawite area of Jabal Mohsen.

Fighting then broke out on Tuesday morning after Sunni gunmen approached some Alawite shops.

(Additional reporting by Oliver Holmes and Laila Bassam in Beirut; Writing by Oliver Holmes; Editing by Jon Hemming)

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Putin ally and MP to table bill doubling jail time for graft

MOSCOW (Reuters) - An ally of President Vladimir Putin said on Tuesday she would table an amendment in parliament to double the maximum jail sentence for corruption to 20 years, urging fellow MPs to back a crackdown on one of Russia's most deep-seated problems.

The statement by Irina Yarovaya, head of a powerful parliamentary committee, appeared to be part of a Kremlin attempt to convince skeptical voters that Putin is serious about cracking down on financial crime.

Former Defence Minister Anatoly Serdyukov is one of a number of officials to have been fired or placed under suspicion in corruption investigations in recent weeks. But opinion polls show many Russians are skeptical about the authorities' motives and the seriousness of their anti-corruption campaign.

Yarovaya, a member of the ruling United Russia party which dominates parliament, said she would propose changes to the law to increase the punishment for embezzlement involving public or state resources.

"Responsibility for these crimes should be higher than for economic crimes. I think ... it should be raised to 20 years in prison," she told a news conference.

The current maximum sentence for such crimes was 10 years in prison, she said. It was unclear whether the kind of amendment she is proposing would pass, but given her status it seems likely it would garner considerable support.

Corruption has blighted Russia since tsarist times with many foreign investors citing it as an obstacle to putting money into the world's largest country, two decades after the collapse of the Soviet Union.

Russia is ranked 143 out of 182 countries on Transparency International's Corruption Perceptions Index, tying with Nigeria on a table where number 1 is the best rank.

NEW LAW ON DECLARATIONS

Putin is widely regarded to have failed to curb corruption since he was first elected president in 2000, despite saying he would impose a "dictatorship of the law".

In his latest attempt to show he is cracking down on graft, he signed a law on Tuesday obliging ministers to declare their spending and that of their families, but even this met with skepticism.

Kirill Kabanov, an anti-corruption activist, told Ekho Moskvy radio that the law would not cover spending abroad, making it less effective.

In other graft cases, the head of the Russian satellite network Glonass has been dismissed in a fraud investigation and a regional governor arrested over accusations that he stole funds meant for September's Asia-Pacific Economic Cooperation summit.

An opinion poll by the independent Levada research center showed that all the recent talk of an anti-corruption campaign had failed to boost support for Putin or for Prime Minister Dmitry Medvedev.

The same survey also showed that some 40 percent of Russians thought the dismissal of Serdyukov was the start of a reshuffle of officials who have been abusing their posts. However, just as many people said they thought it was merely part of a power struggle between various interest groups around Putin.

Russia's Defence Ministry channels billions of dollars every year through the country's arms industry, the world's second-largest defence exporter. A military prosecutor said last year that one fifth of the military budget was stolen.

Putin named a loyalist, Sergei Shoigu, to head the ministry but few see corruption ending.

"This will not change the corruption schemes. This is just a bit of cleansing," said Natalia, a Moscow law student who declined to give her last name. "If it was a genuine fight with corruption, I'm afraid they would have to send all the ministers away".

(Additional reporting by Steve Gutterman; Editing by Andrew Osborn)

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Three killed after cargo ship sinks off Istanbul

ISTANBUL (Reuters) - At least three people were killed and nine others were missing after a cargo ship with a Ukrainian and Russian crew sank in a storm off Istanbul's Black Sea coast on Tuesday.

Two of those who died were rescuers killed when their boat hit rocks in swollen seas as they set off to search for survivors, shipping agency GAC Turkey said. Two other members of that rescue team were missing.

The Volgo Balt 199, which was carrying coal and had 11 Ukrainian and one Russian crew on board, sent an SOS signal at 0730 GMT off the town of Sile on Istanbul's provincial coast but contact with the vessel was lost shortly afterwards.

"Four people were rescued from the ship and one person was found dead. Rescue work continues to find others," Transport Minister Binali Yildirim told reporters.

"Conditions are getting worse because of bad weather. Rescue work is under way with the help of helicopters and boats from the coastguard," he said.

Oleksiy Agafontsev, director of Valship, the operator of the cargo ship, confirmed that four crew members had been rescued and one killed.

A second cargo ship with 14 crew members on board had experienced mechanical failure and was also at risk of sinking, GAC said. Television images showed the second vessel listing heavily in high seas.

Sile lies about 40 km (25 miles) east of the northern end of the Bosphorus Strait, the only maritime outlet for cargo from Black Sea countries, including Russian oil and grain.

Bad weather frequently forces the strait's closure in winter, but GAC said the Bosphorus remained open on Tuesday. About 10,000 vessels carrying 150 million tonnes of oil and petroleum products use the strait every year.

(Additional reporting by Olzhas Auyezov in Kiev; Writing by Nick Tattersall; Editing by Michael Roddy)

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NATO warns Syria not to use chemical weapons

BRUSSELS/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 U.S. government sources said Washington had information that Syria was making what could be seen as preparations to use its chemical arsenal.

Syrian forces meanwhile bombarded rebel districts near Damascus in a sustained counter-attack to stem rebel gains around Assad's power base as the insurgency may be entering a decisive phase.

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 they were used.

Britain has told the Syrian government that any use of chemical weapons would have "serious consequences", Foreign Secretary William Hague said.

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.

CLASSIFIED INTELLIGENCE

The U.S. has collected what has been described as highly classified intelligence information demonstrating that Syria is making what could be construed as preparations to use elements of its extensive chemical weapons arsenal, two U.S. government sources briefed on the issue said.

One of the sources said that there was no question that the US "Intelligence community" had received information pointing to "preparations" under way in Syria related to chemical weapons. The source declined to specify what kind of preparations had been reported, or how close the intelligence indicated the Syrians were to deploying or even using the weapons.

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.

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.

MORTAR ATTACK

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.

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.

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

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Egyptian protesters breach presidential palace cordon

CAIRO (Reuters) - Egyptian police fired tear gas at protesters demonstrating against President Mohamed Mursi's drive to hold a snap referendum on a new constitution and some broke through police lines around his palace, live television footage showed.

Several thousand protesters had gathered nearby in what they dubbed "last warning" protests against Mursi, who has angered opponents with a November 22 decree that expanded his powers. "The people want the downfall of the regime," chanted the protesters.

Mursi ignited a storm of unrest in his bid to prevent a judiciary still packed with appointees of ousted predecessor Hosni Mubarak from derailing a troubled political transition.

Riot police had earlier mustered around the palace as activists chanted "leave, leave" and held up Egyptian flags with "no to the constitution" written on them. Other protesters assembled in front of two mosques north of Cairo before marching towards the palace.

"Many of our national leaders and youth will join us in our marches today," said Hussein Abdel Ghany, a spokesman for the opposition coalition. "Our marches are against tyranny and the void constitutional decree and we won't retract our position until our demands are met."

Still, by early evening there was only a limited response to opposition calls for a mass campaign of civil disobedience in the Arab world's most populous country and cultural hub, where many people yearn for a return to stability.

A few hundred protesters gathered earlier near Mursi's house in a suburb east of Cairo, chanting slogans against his decree and against the Muslim Brotherhood, from which the president emerged to win a free election in June. Police closed the road to stop them from coming any closer, a security official said.

Liberals, leftists, Christians and others have accused Mursi of staging a dictatorial power grab to steamroller through a constitution drafted by an assembly packed with Islamists, with a referendum planned for December 15.

Egypt's most widely read independent newspapers did not publish on Tuesday in protest at Mursi's "dictatorship". Banks planned to close three hours early, one bank official said.

Abdelrahman Mansour in Cairo's Tahrir Square, the cradle of the anti-Mubarak revolt, said: "The presidency believes the opposition is too weak and toothless. Today is the day we show them the opposition is a force to be reckoned with.

"Mursi must come out to talk and hear the people, the opposition," the activist went on. "The opposition says 'no' to the constitution and 'no' to autocracy."

After having pushed the Egyptian military command out of the political driving seat it held for decades, the Islamists sense their moment has come to shape the future of Egypt, a longtime U.S. ally whose 1979 peace treaty with Israel is a cornerstone of Washington's Middle East policy.

The Muslim Brotherhood and its allies, who staged a huge pro-Mursi demonstration on Saturday, are confident that enough members of the judiciary will be available to oversee the December 15 referendum, despite calls by some judges for a boycott.

Cairo stocks closed 3.5 percent up on Tuesday as investors took heart at what they saw as prospects for a return to stability in a country whose divisions have only widened since a mass uprising toppled Mubarak on February 11, 2011.

Mohamed Radwan, at Pharos Securities brokerage, said the Supreme Judicial Council's agreement to supervise the referendum had generated confidence that the vote would happen "despite all the noise and demonstrations that might take place until then".

"NO WAY PERFECT"

Prime Minister Hisham Kandil, a technocrat with Islamist sympathies, said in an interview with CNN: "We certainly hope that things will quiet down after the referendum is completed."

He said the constitution was "in no way a perfect text" that everyone had agreed to, but that a "majority consensus" favored moving forward with the referendum in 11 days' time.

The Muslim Brotherhood, now tasting power via the ballot box for the first time in eight decades of struggle, wants to safeguard its gains and appears ready to override street protests by what it regards as an unrepresentative minority.

It is also determined to prevent the courts, which have already dissolved the Islamist-led elected lower house of parliament, from throwing more obstacles in the way of their blueprint for change.

Mohamed ElBaradei, coordinator of an opposition National Salvation Front, has said Mursi must rescind his decree, drop plans for the referendum and agree on a new, more representative constituent assembly to draft a democratic constitution.

In an opinion piece published in the Financial Times, he accused Mursi and the Brotherhood of believing that "with a few strokes of a pen, they can slide (Egypt) back into a coma".

ElBaradei, a Nobel Peace Prize laureate who once headed the U.N. nuclear watchdog, wrote: "If they continue to try, they risk an eruption into violence and chaos that will destroy the fabric of Egyptian society."

Despite charges that they are anti-Islamist and politically motivated, judges say they are following legal codes in their rulings. Experts say some political changes rushed through in the past two years have been on shaky legal ground.

A Western diplomat said the Islamists were counting on a popular desire for restored normality and economic stability.

"All the messages from the Muslim Brotherhood are that a vote for the constitution is one for stability and a vote against is one for uncertainty," he said, adding that the cost of the strategy was a "breakdown in consensus politics".

(Additional reporting by Tom Perry and Marwa Awad; Editing by Edmund Blair and Mark Heinrich)

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Settlements showdown beckons for Netanyahu in Berlin

BERLIN (Reuters) - Benjamin Netanyahu faces a dressing down from Angela Merkel on Wednesday over his plans to build more Israeli settlements, a policy that has incensed Europe and left even Germany, one of Israel's strongest allies, questioning his commitment to peace.

The issue will overshadow consultations between the German and Israeli governments on issues ranging from Israel's defense and security to greater cooperation in science and research and could further strain already cool working relations between Netanyahu and the German chancellor.

The Israeli prime minister is still smarting from what he considers Berlin's betrayal after Germany abstained in a U.N. vote last week that upgraded the Palestinians' status to "non-member state" from "observer entity".

He had wanted Berlin to vote no.

Netanyahu will stop briefly in Prague on his way to Berlin to thank the Czechs for being the only European state to join Israel and the United States in opposing the resolution, underscoring how important the issue was for him.

Germany says its decision was based on the view that the Palestinians were justified in desiring their own state, but had chosen the wrong way of pushing the issue. It argued that moves in the United Nations rather than talks in the Middle East would only hamper peace and push both sides further apart.

So far, the Germans appear to have been right.

A day after the U.N. General Assembly backed the Palestinian bid, Israel said it would build new dwellings for Jewish settlers.

Such projects, on land Israel captured in a 1967 war, are considered illegal by most world powers and have routinely drawn condemnation from them.

One of the areas Netanyahu said would be subject to preliminary planning work is the so-called "E1" zone east of Jerusalem, a prospect that has stoked particular alarm.

"E1 is not just another settlement. E1 is of enormous strategic importance. E1 ... would cut off East Jerusalem once and for all from the West Bank, thereby making a two-state solution practically impossible," said Ruprecht Polenz, a member of Merkel's Christian Democrats and head of the Foreign Affairs Committee of the Bundestag lower house.

Should E1 go ahead, Netanyahu and Foreign Minister Avigdor Lieberman would "bury the dream of a democratic, Jewish state" by creating instead an entity that would have to include a large Palestinian population, he said in emailed comments to Reuters.

"The (German) government should do everything to turn Israel from this path in the coming inter-governmental talks," he said.

SPECIAL RELATIONSHIP

Germany frequently stresses it will always have a unique relationship with Israel and bear responsibility for the security of the Jewish state after the Nazi-perpetrated Holocaust.

Merkel issued a video message on Saturday saying how much she was looking forward to "friendly discussions" with Netanyahu when they dine together on Wednesday.

She again backed Israel's right to defend its citizens from attack, leaving it to her spokesman Steffen Seibert to issue a surprisingly strong warning on Monday over the settlement plan.

"The Israeli government is sending out a negative message with this move. It is eroding trust in its willingness to negotiate, and the land for a future Palestinian state is disappearing further," Seibert said.

A senior Israeli government official said the Jewish state hoped Merkel would not repeat the admonition herself in public.

Polenz said that Israel should seize the initiative and launch fresh peace talks instead of settlement building.

"I am concerned that with continued settlement building the time frame for a two-state solution will probably run out within the next two years," he said.

Israel cites historical and Biblical links to the West Bank and Jerusalem, saying the future of settlements should be determined through negotiations.

Germany's response may seem muted compared with the strong chorus of criticism from other European capitals, but in German terms it is a notable step.

"We have a unique relationship stemming from our history, and are in a fundamentally different position from our European neighbors. Friendship cannot be questioned, whatever the relations between our governments," said Reinhold Robbe, a former Social Democrat lawmaker and president of the German-Israeli society.

Germany's commitment to Israeli security includes sales of arms. In March, Berlin said it would sell Israel a sixth military submarine and shoulder millions of euros of the cost.

Just last week, according to news magazine Spiegel, Germany's Federal Security Committee agreed to the export of shoulder-fired anti-tank weapons and bunker-busting weapons to Israel to help it defend itself from attacks by Hamas from Gaza.

A defining feature of Merkel's time as chancellor has been her eagerness to engage with Israel herself, rather than hand the portfolio to her foreign minister, as her predecessor Gerhard Schroeder tended to do, Robbe said.

But this means she must now engage in difficult talks with Netanyahu directly and put all subjects on the table, he said.

The two governments will hold a joint session on Thursday when Netanyahu and Merkel will also give a news conference.

(Additional reporting by Jeffrey Heller in Jerusalem; Editing by Gareth Jones and Andrew Osborn)

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U.S. denies Iran's reports of captured drone

DUBAI (Reuters) - Iran said on Tuesday it had captured a U.S. intelligence drone in its airspace over the Gulf in the last few days, but the U.S. military quickly denied having lost any unmanned aircraft in the Middle East.

The incident highlighted tensions in the Gulf as the Islamic Republic and the United States demonstrate their military capabilities in the vital oil exporting region in a standoff over Iran's disputed nuclear program.

Iran has repeatedly threatened to close the Strait of Hormuz - through which about 40 percent of the world's seaborne crude oil is shipped - if it comes under attack. U.S. commanders have said they will not let that happen.

The Islamic Revolutionary Guards Corps (IRGC) said on its website that the ScanEagle drone had been flying over the Gulf in the last few days and was "captured" when it strayed into Iranian airspace.

A spokesman for U.S. Naval Forces Central Command in Bahrain said no U.S. drone had gone missing in the region recently.

"The U.S. Navy has fully accounted for all unmanned air vehicles (UAV) operating in the Middle East region. Our operations in the Gulf are confined to internationally recognized water and air space," Commander Jason Salata said.

Iranian Foreign Minister Ali Akbar Salehi said Iran had warned the U.S. over its violations and the drone was evidence of American incursions which it would use it to pursue its complaint "via international bodies", IRIB News reported.

The IRGC statement did not specify when or where the drone was caught, or whether the unmanned spy plane was shot down or crashed. But it released what it said was video of an apparently undamaged ScanEagle being examined by uniformed officers beneath a sign reading "We shall trample on the U.S." in English.

The incident is the latest in a string of complaints by Iran over what it says are U.S. violations of its territory in an often clandestine conflict over Tehran's nuclear program that has featured assassinations, espionage and cyber sabotage.

The ScanEagle is a 4-ft (1.25-metre) long "off the shelf" spy plane manufactured by U.S.-based Boeing. The company also supplies and operates drones for customers in several Middle Eastern countries, including to help ensure oil platform security in the Gulf, according to its website.

Iran and OPEC rival Saudi Arabia have also accused each other of violating each other's territory near oil and gas fields in the Gulf over the past year.

VIOLATIONS

In November, the United States said Iranian warplanes shot at a U.S. surveillance drone flying in international airspace. Iran said the aircraft had entered its airspace to spy on Iranian oil platforms and said it would respond "decisively" to any incursions.

Days later Iran's ambassador to the United Nations, Mohammad Khazaee, wrote to Secretary-General Ban Ki-Moon to complain about alleged repeated U.S. violations of Iranian airspace, describing them as "illegal and provocative acts".

Khazaee said that U.S. craft had entered southern Iran seven times in October around Bushehr where Iran's only nuclear power station is situated.

A year ago to the day, Iranian forces announced they had captured a U.S. RQ-170 reconnaissance drone in eastern Iran which was reported lost by U.S. forces in neighboring Afghanistan.

Iranian commanders have since announced they have extracted valuable technology from the aircraft and were in the process of reverse-engineering it for their own defense industry.

The United States and its allies believe Tehran is trying to develop nuclear weapons and have imposed tough economic and financial sanctions. Iran says its program is purely peaceful.

Israel has threatened to bomb Iranian nuclear sites if diplomacy and sanctions fail to stop its nuclear activities. In October, Israel shot down an Iranian-made drone launched into the Jewish state by Lebanese Islamist group Hezbollah.

According to Boeing's publicity material, the ScanEagle drone can be launched by a catapult from mobile vehicles or small ships, making it independent of runways.

It can fly pre-programmed or operator-run missions guided by the U.S. Global Positioning System (GPS) and its onboard flight control system.

It is retrieved using a "Skyhook" system in which the drone catches a rope hanging from a 50-ft (16-metre) high pole.

(Writing by Marcus George and Daniel Fineren; Editing by Anna Willard and Paul Taylor)

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