By Allyn Fisher-Ilan

JERUSALEM, Nov 24 (Reuters) - An ally of Israel's prime minister called on Monday for the Jewish state to formally back a six-year-old Arab peace plan for the region, declaring bilateral talks with the Palestinians at a "dead end".

Proposed in 2002, the Arab initiative had long found little interest from Israel, but it has been greeted as a positive step by both Prime Minister Ehud Olmert and his would-be successor, Foreign Minister Tzipi Livni, in recent months.

Interior Minister Meir Sheetrit, a cabinet veteran who is close to both Olmert and Livni, called the initiative "the best channel to achieve peace in the Middle East", including the establishment of a Palestinian state.

The proposal offers Israel peace and normal relations with all Arab countries in return for withdrawal from all territories it captured in the 1967 Middle East war -- the West Bank, the Gaza Strip, East Jerusalem and the Golan Heights.

The plan also calls for the sides to agree to a "just solution" for millions of Palestinians classified as refugees from homes and land taken by the new Israeli state in 1948.

"For the same price as we pay to have peace with the Palestinians, we can have peace with all Arab states," Sheetrit told foreign reporters in Jerusalem.

Livni, who is running for prime minister in a Feb. 10 election to replace Olmert, has praised the initiative, but she has stopped short of endorsing it.

Livni is outspoken in rejecting any right of return for Palestinian refugees to their homes in Israel. Israel also wants to hold onto several large Jewish settlement blocs built in the occupied West Bank after 1967.

Sheetrit said Arab leaders know they will have to compromise, both territorially and over refugees, to get a deal.

He suggested support among Israeli leaders for the Arab initiative was growing because of the realisation that the Israeli-Palestinian track was languishing.

"As a matter of fact, it's a dead end," Sheetrit said. "We are not going anywhere in this situation today."

While Livni has committed to continuing the talks, opinion polls predict victory for right-wing Likud party leader Benjamin Netanyahu, a vocal critic of Olmert's peace proposals.

Sheetrit sees "no chance whatsoever" of any peace deal under Netanyahu, who has said he would continue the talks, but on different terms. (Editing by Giles Elgood)

AlertNet news is provided by