By Simon Gardner and Esteban Israel
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, appeared unwilling to compromise despite being shunned by foreign governments.
The European Commission tightened the screws on Micheletti on Monday by suspending all budgetary support payments to his government. It had earmarked 65.5 million euros (56.1 million pounds) in payments in the 2007-10 period.
As the interim government digs in its heels, more diplomatic and economic sanctions are expected in coming days. Latin American leaders 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 300 pro-Zelaya protesters marched peacefully towards
Congress in the capital Tegucigalpa on Monday, and 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.
UNUSUAL 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.
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.
The interim government, which has been denied around $200 million (121 million pounds) in multilateral aid and $16.5 million in U.S. military aid and is at risk of regional trade sanctions, insists it can and will stand up to the international pressure.
Analysts say Honduras' interim government is biding its 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 Honduran coup is an unusual case. Unlike those that battered Latin America in the 1970s and 1980s, Zelaya's ouster was approved by the Supreme Court and Congress as well as Catholic Church leaders in the country. There is also no military strongman in the picture this time.
Many Hondurans think Zelaya's removal was justified despite widespread disagreement with how it was done.
"They had no choice but to get rid of him. He became crazed with Chavez's ideas and his petro-dollars," said 54-year-old Angela Ramirez, tending her pastry stall in Tegucigalpa.
(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 Simon Gardner; Editing by Kieran Murray)
