By Simon Cameron-Moore
ISLAMABAD (Reuters) - The party of Pakistan's assassinatedformer Prime Minister Benazir Bhutto began stitching together acoalition on Wednesday that could topple President PervezMusharraf, after winning most seats in a general election.
The United States welcomed the vote as "a step toward thefull restoration of democracy", but urged the next governmentof the nuclear-armed country to work with Musharraf.
Musharraf is a key Muslim ally for the United States in itsfight against al Qaeda, and also oversaw better ties with rivalIndia. But neighbours and allies now fear Pakistan is becomingmore unstable and economic gains could be squandered.
Pakistani stocks edged to a life-high in early trade, asinvestors registered relief that the vote was less violent andfairer than feared, saying it was a first step towardsstability.
A wave of sympathy helped Bhutto's Pakistan People's Party(PPP) win the most seats in the National Assembly in Monday'selection, in which the allies of former army chief Musharraf,who seized power in a 1999 coup, suffered big losses.
But the PPP needs coalition partners and the president'scamp is banking on persuading it to invite the pro-MusharrafPakistan Muslim League (PML) to salvage his leadership.
Bhutto's widower Asif Ali Zardari, who took over as PPPleader after she was killed in December, appeared to take thatlifeline away by saying his party would not invite anyone fromthe PML into a broad-based coalition it planned to form.
Zardari told the BBC's Urdu-language service on Tuesdaythat Musharraf had said he would quit if he no longer had thepeople's support, and vowed that the PPP would put the issue ofthe president's future before parliament.
Asked by the Wall Street Journal if he had contemplatedresigning, Musharraf replied: "No, not yet. We have to moveforward in a way that we bring about a stable democraticgovernment to Pakistan."
"The prime minister runs the government. The president hashis own position, but has no authority running the government,"he told the newspaper.
But he was opposed to any move to reinstate judges he usedemergency powers to replace before they could annul hisre-election by the last parliament in October.
DIVIDING LINE
The PPP wants Nawaz Sharif, the prime minister Musharrafoverthrew in 1999, to join the coalition along with an ethnicPashtun party that kicked Islamist parties out of power in theNorth West Frontier Province where militants operate.
"The dividing line is whether you were with thedictatorship or whether you were with those forces who werestruggling for democracy," senior PPP member Taj Haider toldDawn Television.
Sharif, whose party ran a close second in Monday's poll,has made driving Musharraf from power his mission sincereturning from exile in Saudi Arabia in November, a month afterBhutto.
According to unofficial results for 261 seats, the PPP,Sharif's party and the Awami National Party (ANP) held a shadeunder the two-thirds they need to change the constitution orbring Musharraf down, but independents could join their banner.
"This is an excellent result for moderate forces. It's areturn to a proper civilian government with political forceswho have a proper mandate," said Kamal Jabbar, a lawyer inKarachi.
Analysts warned ideological differences and past bad bloodcould still scupper an alliance between the PPP and Sharif, inwhich case, the PPP's door could re-open to Musharraf'sfriends.
The president's emissaries made little headway when theymet Zardari late on Tuesday, according to officials.
Political paralysis has played havoc with management of theeconomy in the last six months.
Pakistanis have struggles with soaring fuel prices,shortages of basic foods and gas, and worsening power cuts,while investors in stocks fear further political upheavalscould puncture a booming stock market.
But the Karachi Stock Exchange main index has bucked abearish trend across Asia to recover all losses suffered afterBhutto's murder. A 40 percent gain in 2007 made it one ofAsia's best performers, and it has gained about 900 percentsince 2000.
The rupee gained nearly 1 percent against the dollar in thelast two days, having been bumping 6-year lows.
MUSHARRAF'S CHOICES
Musharraf's popularity has largely disintegrated over thepast year, especially after he imposed a stint of emergencyrule in November, purging the judiciary and gagging the media.
In Washington, State Department spokesman Tom Casey saidthe U.S. administration hoped "whoever winds up in charge ofthe new government would be able to work with (Musharraf)".
Zardari and Sharif are due to meet on Thursday.Negotiations could last for days. But, if they agree, it wouldleave Musharraf with two choices, said analysts.
He could either quit or drag out political upheavals with ahostile parliament that would try to oust him on grounds heviolated the constitution when he imposed emergency rule.
"He has the graceful option and the confrontationaloption," said Ijaz Shafi Gilani, chairman of pollsters GallupPakistan. "My sixth sense is that he will leave."
(Additional reporting by Sahar Ahmed; Editing by RobertBirsel and Alex Richardson)
(To read more about the Pakistan election double click onand visit the Reuters blog "Pakistan: Now or Never?" athttp://blogs.reuters.com/pakistan/)
