(Adds U.N. comments, Indian envoy arrives)

By Gopal Sharma

KATHMANDU, Oct 10 (Reuters) - The chief of Nepal's former Maoist rebels threatened that they could bring down the interim government if it does not agree to their demands, including an immediate end to the monarchy, newspapers reported on Wednesday.

It is the strongest warning yet from Prachanda, the Maoist chief, since last week's talks failed to end the dispute over the monarchy and the rebels' demand for proportional representation in forthcoming elections.

The threat is the latest blow to a peace deal reached last November which brought an end to a 10-year civil war. On Wednesday, the United Nations blamed both sides for allowing cracks to appear in the peace process.

On Thursday the interim parliament is due to discuss the issue of the monarchy in an emergency session.

"If there is disagreement on several issues, the Maoists will launch an agitation and the government may have to be changed," Prachanda, who still goes by his nom de guerre, was quoted as saying in the Himalayan Times.

He said if the Maoists were still unhappy after the session then they would "turn the current constitution into a useless piece of paper," according to the Kathmandu Post.

He was speaking to reporters in the town of Dipayal in western Nepal.

Around 13,000 people were killed during the Maoist civil war and in their quest for a republic. A peace deal was reached last November, and the Maoists locked up their guns and joined a newly formed interim government.

The cornerstone of the deal was that an election be held to form a constituent assembly to map out the political future of the country and decide what to do with King Gyanendra, the country's unpopular and increasingly impotent monarch.

The election was meant to take place on Nov. 22. But analysts say the Maoists started to worry they might perform poorly.

In the hope of energising their supporters and differentiating themselves from other parties, they pulled out of the government, demanding an immediate abolition of the monarchy and a full system of proportional representation.

Talks have so far failed. The election has now been postponed indefinitely, although Prachanda said it could take place in April if the deadlock ended, the Kathmandu Post reported on Wednesday.

The interim constitution gives parliament exceptional powers to abolish the monarchy before the election if the king is interfering with the process. The Maoists insist this is happening. The government disagrees.

Analysts say that the Maoists still have the power to disrupt the government with large street protests and strikes.

The head of the U.N.'s Nepal mission, Ian Martin, said both the government and Maoists needed to do more to keep the peace process on track.

Thousands of former Maoist guerrillas are camped in U.N.-monitored cantonments, but they complain of poor living conditions. The issue of integrating them into the army has also not been addressed.

"The lack of progress within the government in discussing the future of Maoist combatants, ensuring adequate conditions in the cantonments, and commencing serious discussions on security sector reform, have all contributed to Maoist concerns that the government is not fulfilling its commitments," Martin said.

The reluctance of the Maoists to ensure their cadres ended intimidation and violence has "badly eroded public confidence that the Maoists are indeed willing to enter a genuinely democratic process", he added.

Martin said Nepal also needed to hold talks with marginalised groups, including from the southern Terai plains where violent protests broke out this year.

He also called for the government to improve public security and fix a new date for the delayed election.

On Wednesday Shyam Saran, a senior Indian diplomat, arrived in Kathmandu as a special envoy of the Indian government to push for the peace process and democracy.

New Delhi is a key trade and aid partner of impoverished Nepal and helped bring the Maoists and mainstream political parties together in 2005.

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