ISTANBUL, May 10 (Reuters/Daren Butler) - Muslim leaders warned on Monday the establishment of new Israeli settlements in Jerusalem would push the region to the brink of an abyss, a day after Palestinians declared the start of indirect talks with Israel.

Palestinians say the US-mediated talks will become direct if Israel announces a complete halt to settlement building on occupied land. Turkish Prime Minister Tayyip Erdogan, a strong critic of Israel, stressed the importance of such a move.

Jewish settlement activities, which represent the biggest obstacle to the peace process, must be halted, he told a meeting of Organisation of the Islamic Conference (OIC) nations.

A draft Istanbul declaration of the OIC's Parliamentary Union condemned what it said were provocative Israeli acts at holy places in Jerusalem and urged the international community to prevent geographical and demographic changes in the city.

(The meeting) warns Israel that its intransigence and persistent defiance of the international community by the establishing new settlements in Al-Quds (Jerusalem) will push the region to the brink of an abyss, it said.

The Palestinians aim to establish a state in the West Bank and Gaza Strip with East Jerusalem as its capital. Israel captured those areas in a 1967 war and regards all of Jerusalem as its capital, a claim not recognised internationally.

Israeli Prime Minister Benjamin Netanyahu, who heads a coalition government dominated by pro-settler parties, has rejected a total freeze on construction of Jewish settlements in occupied territory.

After Sunday's meeting, US Assistant Secretary of State Philip Crowley said Netanyahu would freeze for two years a plan for hundreds of housing units in an East Jerusalem settlement.

However a Netanyahu aide, who declined to be named, denied the Israeli leader had specifically agreed to freeze the plan.

No new Israeli housing projects in East Jerusalem have been approved since March, raising speculation Netanyahu has imposed a de facto moratorium that could keep talks going while avoiding a falling-out with his far-right coalition partners.

ERDOGAN SCEPTICAL ABOUT TALKS

Turkey, a Muslim but constitutionally secular state, has a record of military cooperation with Israel and has acted as an intermediary between the Jewish state and the Arab world.

But warmer relations between Ankara and Muslim neighbours including Iran and Syria have raised concerns that Ankara's traditionally Western-anchored foreign policy is moving east.

Erdogan has repeatedly and strongly criticised Israel's offensive in Palestinian-ruled Gaza at the end of 2008. He stormed out of a panel discussion in Davos after a spat with Israeli President Shimon Peres in January 2009.

He voiced further criticism at the Istanbul meeting on Monday and called for an end to restrictions on the daily lives of Palestinians hampered by security checkpoints.

Palestine must be rescued from being an open-air prison ... While this tragedy is continuing in Gaza I cannot be very optimistic that the peace talks will produce positive results.

US plans for indirect talks were foiled in March when Israel angered Washington and the Palestinians by announcing during a visit by Vice President Joe Biden a project to build 1,600 new homes in the Ramat Shlomo settlement.

OIC Secretary-General Ekmeleddin Ihsanoglu told the Istanbul meeting that Jerusalem was facing its worst days ever and that diplomatic action and condemnation could not address the challenge posed by Israeli settlements alone.

Israel is taking advantage of the international community's lassitude with its policies and carrying out a hideous plan aimed at depopulating the city of al-Quds of its Palestinian citizens, he said.