(Adds details from Negroponte testimony)

By Susan Cornwell and Caren Bohan

WASHINGTON, Nov 7 (Reuters) - U.S. President George W. Bush telephoned Pakistan President Pervez Musharraf on Wednesday and urged him to restore democracy, as a top U.S. diplomat warned lawmakers against cutting aid to an "indispensable" ally in the war on terrorism.

In his first direct talk with Musharraf since the general declared a state of emergency last Saturday, Bush urged the Pakistani leader to hold elections and give up his military post.

"My message was that we believe strongly in elections and that you ought to have elections soon and you need to take off your uniform. You can't be the president and the head of the military at the same time," Bush said at a joint news conference with French President Nicolas Sarkozy.

"I had a very frank discussion with him," Bush said.

The State Department said on Tuesday that after Musharraf's broad crackdown on opposition, it was committed to a thorough review of aid to Pakistan, which has received nearly $10 billion in U.S. funds since the Sept. 11 attacks.

Some lawmakers have accused the Bush administration of coddling Musharraf and demanded tougher steps against the military officer who has run the nuclear-armed country since a 1999 coup.

But Deputy Secretary of State John Negroponte told Congress on Wednesday U.S. assistance was needed in Pakistan to help moderates resist violent extremists who also threatened U.S. security.

Negroponte told lawmakers that Bush considered Musharraf, who has supported Washington in the fight against al Qaeda and the Afghan Taliban since 2001, "indispensable in the global war on terror."

There was no option, the deputy secretary of state argued, but to continue the U.S.-Pakistani relationship, while pushing for building a stable, democratic society there.

Negroponte said U.S. economic and reconstruction programs, as well as security and law enforcement training in tribal areas of Pakistan, were critical to fighting terrorism and nurturing democratic ideas.

"Cutting these programs would send a negative signal to the people of Pakistan," Negroponte told the House Foreign Affairs Committee. "Our programs are empowering Pakistan's moderate center to resist and eventually defeat a violent anti-democratic minority."

"Pakistan's future is too vital to our interests and our national security to ignore or down-grade," he said.

The State Department's judgment, he said, was that no suspension of aid was automatically triggered by the current situation. But if it continued indefinitely, that would "undercut support for continued -- at least, certain aspects of our assistance program."

Pakistan government officials have said national elections due in January will be held on time and a member of Musharraf's inner circle said emergency rule was likely to be lifted within 2 or 3 weeks. But Musharraf, who took power in a 1999 coup, has not yet personally confirmed either.

California Republican Rep. Ed Royce took issue with the description of Musharraf being an "indispensable" ally.

"The one thing that is indispensable in Pakistan is the rule of law," Royce told Negroponte. "The rule of law has been frankly, overturned."

(Editing by David Alexander and Stuart Grudgings)

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