By Crispian Balmer
JERUSALEM (Reuters) - Both sides of Israeli-Palestinian peace talks risk paying a high price in losing European Union trade and aid if negotiations collapse, the EU ambassador to Israel said on Wednesday.
For long seen as a "payer not a player" in the region, the European Union has started making clear that its role as Israel's biggest trade partner and the Palestinians' largest donor should not be taken for granted.
"We have made it clear to the parties that there will be a price to pay if these negotiations falter," ambassador Lars Faaborg-Andersen told reporters.
U.S. Secretary of State John Kerry is trying to draw up a broad framework deal that would open the way for a final round of detailed discussions to end the generations-old conflict covering all the core elements dividing the two sides.
However, despite more than five months of talks, there has been no sign of any imminent breakthrough.
The EU has grown especially frustrated by Israel's repeated announcement since the talks started of new Jewish settlement building on land the Palestinians want for their future state.
"If Israel were to go down the road of continued settlement expansion and were there not to be any result in the current talks, I am afraid that what will transpire is a situation where Israel finds itself increasingly isolated," he said.
A major private Dutch pension fund announced earlier this month that it was divesting from five large Israeli banks because of their operations in the settlements, and Norwegian and Swedish funds are considering similar moves.
While EU states are not advising firms to cut investments in Israel, officials say companies might act unilaterally to avoid any backlash from clients increasingly disenchanted with continued Israeli occupation of land seized in the 1967 war.
Israel's pro-settler economy minister, Naftali Bennett, on Monday made light of the possibility of a boycott on Israel and has suggested that the government should look to bolster ties with emerging markets to offset problems with Europe.
Despite Israel's intimate ties with the United States, the European Union is its biggest economic partner, accounting for almost a third of the country's exports and imports. Faaborg-Andersen questioned how quickly Israel could change focus.
"To think you can shift all your cooperation, trade, everything overnight to India, China and Russia, well I have my doubts," he said.
The 28-nation EU has potentially even more leverage over the Palestinians, providing some 1 billion euros of assistance each year to the cash strapped Palestinian Authority, making it by far the largest donor to the West Bank economy.
"It has been made very clear to the Palestinians that just sitting around and waiting is not an option," said Faaborg-Andersen, warning that donor fatigue was already setting in.
However, the ambassador said Israel also risked losing out if an increasingly frustrated EU decided to cut PA funding.
"I think it is realized in Israel that this money is key to the stability of the West Bank and in Gaza. If we don't provide the money … I think there is a great likelihood that Israel would have to provide far more."
(Editing by Sonya Hepinstall)