In a blunt two-way warning aimed at stemming both ethnic divisions and growing Iranian influence in Iraq, the US Ambassador in Baghdad threatened to cut American aid to the country unless its new government moved away from sectarian agendas.

"Sectarian and ethnic conflict is the fundamental problem in Iraq,"said Zalmay Khalilzad after talks to form a new government again stumbled today over disagreements between Shias, Sunni Arabs and Kurds.

"American taxpayers expect their money to be spent properly. We are not going to invest the resources of the American people into forces run by people who are sectarian."

The result of the December elections gave a clear victory to non-secular, ethnicity based parties in 13 out of the Iraq’s 18 provinces. The country’s Shia Muslims emerged as the dominant power block in the nascent government, winning 130 of the 275 seats in parliament.

Yet subsequent to the nomination this month of the Shia Prime Minister, Ibrahim al-Jaafari, for another term at the post, talks between the parties have foundered over the formation of the new government, and key posts remain undecided.

Regarded with a degree of optimism by foreign diplomats a few weeks ago, the political process is now veering toward the creation of an ethnically divided government in which the ministries are carved up along the lines of religion and race. It is a template similar to that which propelled Afghanistan into a quarter-century of civil war.

While Sunni Muslim leaders accuse the current Shia-led Interior Ministry of running death squads to kill and repress their people and Shia civilians reel under the bomb attacks of Sunni militants, Iran has entered the game with a strong hand, playing to exert influence through its good relations with Iraq’s Shia Muslim majority.

"Iran has another policy as well: to work with militias, provide training and provide weapons to extremist groups, direct and indirectly," said Mr Khalilzad in a message directed at Iraq’s Shia leaders.

He added that the Iranian Foreign Minister’s recent call for British troops to withdraw from the southern city of Basra was "uncalled for interference". "Basra is Iraqi territory the last time I checked the map," he said.

Long accused of supplying arms to Shia groups, Iran’s involvement with insurgents has accelerated in the wake of Saddam Hussein’s fall, allowing it unprecedented influence in the region.

Both the al-Mahdi Army belonging to Hojatoleslam Moqtada al-Sadr, the radical Shia cleric and former outlaw who threw his weight behind Mr al-Jaafari’s nomination for prime minister, and the Badr Brigade of the pro-Iranian Supreme Council for the Islamic Revolution in Iraq (SCIRI) have benefited from their relationship with Tehran, to the chagrin of America and Britain.

Political leaders in Baghdad have yet to begin serious negotiations on the precise formation of the new government and though President Jalal Talabani said today that the government could be launched within a month, observers warn that the process could take weeks.

As bomb attacks in Baghdad and Mosul killed at least 20 people today, a Macedonian company announced that two of its employees, both ethnic Albanians, had been released four days after being abducted by gunmen in Basra.

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