Israel Must Freeze Settlements to Get Loans, Baker Says : Mideast: Shamir accuses Washington of siding with Arabs, hopes for compromise. Dispute over $10 billion in loan guarantees strains ties as peace talks resume.

Israel must stop all settlement activity--including road, sewer and water projects--in the West Bank and Gaza Strip and leave partly built houses unfinished if it hopes to receive American guarantees for $10 billion in loans it has requested to resettle immigrants from the former Soviet Union, Secretary of State James A. Baker III said Monday.

In frequently acrimonious exchanges with Israel’s supporters on Capitol Hill, Baker laid out terms that were even stricter than those outlined privately by American and Israeli officials.

The increasingly emotional dispute put a severe strain on the Washington-Jerusalem relationship as U.S.-brokered Middle East peace talks resumed in Washington. But Baker’s stand was applauded by Arab delegations, which had hinted that they would pull out of the negotiations if the Bush Administration approved unconditional loan guarantees.

Talking to a House Appropriations subcommittee, Baker said that the Administration is willing to relax only slightly its demand for an immediate freeze. He said that Prime Minister Yitzhak Shamir’s government may complete projects that were under way on Jan. 1, provided that the cost of the work is deducted dollar for dollar from the loan guarantees. No new starts would be permitted.

“This Administration is ready to support . . . absorption assistance to Israel of up to $2 billion per year for five years, provided there is a halt . . . to settlement activity,” Baker said. “The choice . . . is Israel’s.”

Yosef Ben-Aharon, Shamir’s chief of staff and a leader of Israel’s delegation to the peace talks, said he still hopes for a compromise. He said Israel is ready to promise not to spend any of the loan money in the occupied territories, although it will not restrict the use of funds from other sources.

Administration officials have said they will not accept that kind of deal because Israel has accelerated settlement activity despite a similar promise that it made last year to obtain $400 million in loans.

Although the Administration has made no secret of its intention to use the current request for loan guarantees to pressure Israel to suspend construction of Jewish settlements in the occupied territories, Baker’s remarks were the first official confirmation of Washington’s terms.

Shamir, who has insisted that his government will never stop building homes for Jewish settlers in the West Bank and Gaza, complained Monday that the Administration had sided with Arab governments that he said oppose all Jewish immigration to Israel, regardless of where the new residents choose to live.

“The reason for the Arabs’ opposition to the loan guarantees is clear,” Shamir said in a speech to Jewish-American leaders in Jerusalem. “First, their radical, permanent opposition to Jewish immigration. . . . Secondly, they want to create a Palestinian state.

“Why and since when does the United States identify with this Arab position?” he said. “It is difficult to accept it, and we believe that the United States will yet change their policy.”

With Israel facing general elections in June, it would be political suicide for Shamir to appear to knuckle under to American dictates . At the same time, growing friction between his government and the United States, Israel’s closest ally, is also politically damaging to the right-wing prime minister.

Although the U.S. government insists that it is neutral in the Israeli election, it is no secret that the Administration would prefer to deal with a government led by the opposition Labor Party, which is usually more flexible in its approach to the Arab-Israeli peace process.

But in his speech to a meeting of the Conference of Presidents of Major American Jewish Organizations, Shamir predicted that no Israeli government would agree to freeze settlements.

“We cannot under any circumstances go along with the principle that Jews have no right to live in this or that part of the Land of Israel,” he said, using the term that designates both Israel’s internationally recognized borders as well as the disputed West Bank and Gaza Strip. “My friends, I do not believe that any government of Israel that will be formed after June 23 would agree to such a demand or condition.”

Yitzhak Rabin, the Labor candidate for prime minister, also rejected a freeze but said he would sharply curtail settlement construction.

Housing Minister Ariel Sharon said that work has begun on 2,000 more housing units in the West Bank and Gaza and in Arab neighborhoods of Jerusalem since the beginning of the year and that work on another 1,000 will get under way soon.

In the resumed peace talks, Israel negotiated separately with Syrian, Lebanese, Jordanian and Palestinian delegations. No breakthroughs were reported.

Palestinian spokeswoman Hanan Ashrawi said that Baker’s loan conditions will put the negotiations “back on the right track.” Asked if she is happy with Baker’s announcement, Ashrawi said: “The Palestinians haven’t been happy in a long time. It’s a question of seeing a glimmer of hope.”

Ben-Aharon, speaking at a news conference at Israeli delegation headquarters, said that his government wants to separate the loan issue from the peace talks. He said that Israel still hopes to have both settlements and the loans. “We will not capitulate on the settlements, and we will not write off the loan guarantees,” Ben-Aharon said.

Although Rep. David R. Obey (D-Wis.), chairman of the House Appropriations subcommittee, urged Baker to hold firm in his opposition to settlements, other members of the panel complained that the Administration is demanding concessions from Israel while asking nothing of the Arabs.

“Nobody else is asking us for $10 billion in additional assistance over and above the $3 (billion) to $4 billion that we give every year with no strings attached,” Baker said.

When Rep. Lawrence J. (Larry) Smith (D-Fla.) interrupted to say that the guarantees would cost the taxpayers nothing, Baker said tartly: “Do you want me to answer your question, or do want to filibuster? . . . I think I probably finished the answer anyway.”

“Well, sir, you did not finish the answer,” Smith said.

“I finished it as far as I was concerned, and I will determine when I finish my answers, not you,” Baker said.

Times staff writer Daniel Williams in Jerusalem contributed to this report