An investigation into alleged corruption against Benazir Bhutto has been dropped, fuelling speculation that the former prime minister of Pakistan is set to return from exile.

A special investigations unit charged with pursuing the case against Miss Bhutto and other politicians has been closed, apparently under orders of President Musharraf.

Miss Bhutto, who fled in 1999 to avoid arrest on graft charges, would be free to return to Pakistan in time for parliamentary elections, which are expected to take place before the end of this year.

In return, her Pakistan People’s Party would help to bolster General Musharraf’s precarious political position and support his reelection as president for another five-year term. General Musharraf seized power in a bloodless coup in 1999.

This week the Government closed an anticorruption department that was investigating foreign assets and offshore bank accounts allegedly held by Miss Bhutto and her husband, who have been living in London and the United Arab Emirates. Hassan Wasim Afzal, a senior official at the National Accountability Bureau who was leading the case, was transferred to a post in the Punjab provincial administration.

Sources close to both sides have confirmed that negotiations between the military and Miss Bhutto have reached a crucial stage and that an alliance, once unthinkable, was very much a possibility.

The United States and Britain are believed to be in favour of such an alliance, which they believe could weaken the radical Islamic parties.

General Musharraf’s military intelligence chiefs have made several trip to London in recent weeks in an attempt to secure an agreement. This would likely include the dismissal of all charges against Miss Bhutto, who has not been convicted by any court, and a promise that General Musharraf would leave the army to serve as a civilian president.

Negotiations have gained fresh urgency since General Musharraf became engulfed in a serious political row after his decision last month to sack the Chief Justice of the Supreme Court. The move, which led to violent protests, was seen as an assault on the independence of the judiciary and gave his opponents a common cause.

Political observers agree that General Musharraf has almost run out of options as he seeks reelection. He faces a stark choice of either going with the conservative Islamists, who oppose his his pro-American policies, or to ally himself with Miss Bhutto’s liberal Pakistan People’s Party.

He is under pressure from America to crack down on the radical Islamists who are spearheading militancy and religious extremism. The creeping Talebanisation of Pakistan’s northern border areas presents the most serious threat to the country’s internal political stability and to the regional security.

A series of terrorist attacks in Pakistan in recent months signalled an escalation in the confrontation between the security forces and the Islamists.

Despite her years in exile, Miss Bhutto is still the most powerful political figure in Pakistan. Her party received the highest number of votes in the last parliamentary election held in 2002.

Under the constitution Miss Bhutto cannot be elected as prime minister for a third time, but she could put forward a nominee to head a government after the elections.

An alliance would represent a serious setback for Nawaz Sharif, a former prime minister whose government was overthrown by General Musharraf’s military coup.

Mr Sharif, who also lives in exile in London, signed an earlier agreement with Miss Bhutto, setting aside their differences to work together towards a return to full democracy in Pakistan. However, this accord appears to be broken by Miss Bhutto’s latest negotiations with the military.

Slings and arrows of fortune

1977 General Zia-ul-Haq imposed martial law in Pakistan. Benazir Bhutto’s father, Shaheed Zulfikar Ali Bhutto, below, was arrested on a murder charge; she was placed under house arrest

1979 Miss Bhutto’s father was hanged. She succeeded him as leader of Pakistan People’s Party, and then spent seven years in exile or under house arrest

1984 Escaped into exile in Britain on medical grounds, after nearly six years in jail

1988 Having returned, she became the youngest, and the first woman Prime Minister in Pakistan or any other modern Muslim nation

1996 Miss Bhutto removed from Government for second time by President Leghari, on charges of mismanagement and corruption

2006 Interpol issued notices for the arrest of Miss Bhutto and her husband at request of the Pakistani Government

Source: Benazir Bhutto website; Times Archive

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