Pressure builds on Honduras

TEGUCIGALPA (Reuters) - Honduras' de facto leader came under increased pressure on Monday to hand power back to the ousted president with Europe halting economic aid and top Latin American officials warning of bloodshed if he does not back down.

Efforts to broker an end to the power struggle in Honduras following a June 28 military coup collapsed on Sunday after interim leader Roberto Micheletti rejected a proposal to reinstate overthrown President Manuel Zelaya.

Costa Rican President Oscar Arias, the frustrated peacemaker in the talks, asked both sides to give him until Wednesday to broker a solution to the crisis. But Micheletti, who was appointed by Honduras' Congress after the coup, remained defiant despite being shunned by foreign governments.

"My position is unchangeable," he said in a speech on Monday at the presidential palace to a standing ovation.

The European Commission tightened the screws on Micheletti by suspending all budgetary support payments to his government. It had earmarked 65.5 million euros (56.3 million pounds) in payments in the 2007-10 period.

He had previously been denied around $200 million in multilateral aid and $16.5 million (9.97 million pounds) in U.S. military aid.

As the interim government digs in its heels, more diplomatic and economic sanctions are expected in coming days, although the United States has so far been reluctant to become a decisive player.

Latin American leaders increasingly fear violence in the impoverished Central American country unless Micheletti steps aside.

"Insurrection and confrontation are not a good path to take, but I don't think we will avoid it unless the de facto government shows some flexibility," said Jose Miguel Insulza, the chief of the Organisation of American States.

Insulza also pleaded with Zelaya to wait out the 72 hours requested by Arias before staging a return to Honduras from exile in Nicaragua.

Zelaya says resistance is being organized in Honduras to pave the way for his return this weekend and that nobody can stop him. His enemies have threatened to arrest him if he returns and police have warned his supporters they will "not be tolerant with anyone who acts like a terrorist."

Zelaya tried to return to Honduras earlier this month but soldiers blocked the runway and at least one protester was killed in clashes with the army.

Around 400 pro-Zelaya protesters gathered peacefully outside Congress in the capital Tegucigalpa on Monday, some waving the blue and white Honduran flag, others red flags of Zelaya's Liberal Party. Riot police stood by.

Unions have called for a two-day national strike on Thursday and Friday.

"This is just the start. For now, these are peaceful protests but things could get a lot worse," said Wilfredo Moncado, a 59-year-old union leader who joined the march.

A DIFFERENT COUP

Zelaya was expelled from the textile and coffee exporting country in his pyjamas in the middle of the night. He had upset his political rivals by trying to lift presidential term limits and the army toppled him after the Supreme ordered his arrest.

The crisis is widely seen as a litmus test for U.S. President Barack Obama as he seeks a fresh start with Latin America despite ideological differences with vocal U.S. foes like Venezuelan President Hugo Chavez, a close ally of the deposed Honduran leader.

Micheletti has a base of local support in business circles as well as the Supreme Court, Congress and the Catholic Church, making this coup unlike those that battered Latin America in the 1970s and 1980s.

On Monday, he urged business leaders to continue investing in Honduras and asked his supporters to help him try to turn the tide of world opinion in his favour.

Analysts say he is biding his time so that Zelaya's reinstatement becomes a moot point. His term was due to end in January, and elections were scheduled for November.

The U.S. State Department put a positive spin on the failed crisis talks by extolling the "progress" made, but Insulza of the OAS was more sanguine on Monday.

"It is almost impossible to call for calm when the dictatorship seeks to test everyone's patience and stay in power," he said.

(Additional reporting by Gustavo Palencia in Tegucigalpa, Juan Casas and John McPhaul in San Jose, Tim Gaynor in Washington and Rodrigo Martinez in Santiago; Writing by Louise Egan; Editing by Kieran Murray)