Following a meeting of Prime Minister Atal Behari Vajpayee's security cabinet, India announced it would halve the two countries' embassy staff in Islamabad and New Delhi and ban Pakistani aircraft from flying over Indian air space.

Pakistan swiftly announced reciprocal measures.

"Such efforts will only increase tension and we are forced to take retaliatory actions," Pakistan's Foreign Ministry spokesman Aziz Ahmed Khan said.

Indian Foreign Minister Jaswant Singh said the sanctions were the result of Pakistan's attempts to "dupe" the world with "cosmetic measures and non-measures" against militant groups operating in its territory.

The air space ban will take effect on January 1, and the embassy downgrade in 48 hours, Singh said, adding that all remaining Pakistani High Commission staff would be confined to New Delhi.

Each country has an embassy staff of 110 in the other.

The new sanctions followed last week's recall of the Indian envoy to Pakistan and the snapping of bus and rail links between the nuclear rivals, which have fought three full-scale war since their 1947 independence from Britain.

The crisis stems from India's accusation that Pakistani military intelligence sponsored the December 13 attack on the parliament complex in New Delhi and its threat of military retaliation.

The United States responded to another day of rising tensions between India and Pakistan Thursday by making clear it expects both to step back from confrontation.

A State Department official said both sides acted within their rights by imposing reciprocal sanctions, but should carefully examine the implications.

"Each country has the sovereign right to take diplomatic steps it believes necessary to preserve its security," said the official, speaking on condition of anonymity.

"We expect that both are giving careful consideration to how most effectively to resolve the situation that confronts them."

The official said Washington was keeping in "close touch" with both sides following a flurry of telephone diplomacy which cut in to Secretary of State Colin Powell's Christmas holiday.

New Delhi has demanded that Islamabad shut down the two Pakistan-based Kashmiri militant groups blamed for the attack -- Lashkar-e-Taiba and Jaish-e-Mohammad -- seize their assets and arrest their leaders.

Indian Defence Minister George Fernandes described the situation as "grave" but said diplomatic efforts should be given time even as fresh troops were being moved to the border.

"In the next two to three days, the deployment process will be completed and the forces will be ready for any eventuality," Fernandes said.

In Islamabad, military spokesman Major General Rashid Qureshi said Pakistan could retaliate in "all conceivable ways" to any Indian escalation of their dispute but described a nuclear war as unthinkable.

"These (nuclear weapons) are deterrents which are not meant to be more than that. It's something that I think one shouldn't even consider," Qureshi said.

Pakistan has frozen Lashkar's assets and says it has arrested the founding head of the Jaish militant group, Maulana Masood Azhar.

However, Singh said the accounts frozen had already been emptied and that it was Azhar's brother who had been arrested, while the whereabouts of the Jaish leader were unknown.

"This is not acceptable," Singh said.

"All that is expected really is a recognition of the enormity of what has happened and the sense of outrage caused across the length and breadth of India.

"Then (Pakistan) must take the necessary consequential steps."

Pakistan reiterated its willingness for talks between Musharraf and Prime Minister Vajpayee at next week's South Asia regional summit in Kathmandu, but Singh rejected the suggestion outright.

"It is not practical, it is not possible," he said, while confirming Vajpayee would attend the summit.

The meeting has been effectively scuttled by India's ban on Pakistani overflights, an analyst in Islamabad said Thursday.

"Effectively the Indians have foreclosed Pakistan's participation in SAARC and therefore scuttled it," said Riffat Hussain of Islamabad's Quaid-e-Azam University.

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