By Jeffrey Heller
JERUSALEM, May 6 (Reuters) - Benjamin Netanyahu, locked in down-to-the-wire coalition talks, faces a midnight deadline to form a government or risk being denied a fourth term as Israel's prime minister.
Nearly two months after a convincing election victory, Netanyahu is struggling to build a solid parliamentary majority, with a former ally abandoning him this week.
The key to his political future now lies with the ultranationalist Jewish Home party, which advocates annexation of parts of occupied territory Palestinians seek for a state.
Shortly after the March 17 vote, Netanyahu and his Likud party appeared to be coasting toward a right-leaning government with control of 67 of parliament's 120 seats.
But on Monday, Foreign Minister Avigdor Lieberman, whose once-strong relationship with the Israeli leader turned sour long ago, dropped a bombshell by taking his far-right Yisrael Beitenu party out of the coalition talks.
That left Netanyahu with the support of two ultra-Orthodox Jewish parties and a centrist faction, a total of 53 seats, making the addition of Jewish Home's eight legislators crucial for a majority.
Such a narrow government would make Netanyahu vulnerable to policy demands from even his most junior coalition partners, continuing a long tradition of unstable politics.
Jewish Home is certain to push for the expansion of Jewish settlement in occupied territory, a policy that could deepen Israel's rift over the issue with its main ally, the United States, and the European Union.
The party's leader, Naftali Bennett, has called for the annexation of parts of the West Bank. That goes beyond Netanyahu's pledge to continue to build in settlements in areas Israel intends to keep in any future peace deal with the Palestinians.
Bennett is also a strong supporter of a bill, promoted by Netanyahu, that would anchor in law the status of Israel as the nation-state of the Jewish people. Critics, among them Israel's President Reuven Rivlin, have said it runs counter to the founding fathers' vision of equality for Arab citizens.
Other proposed legislation likely to be pursued by a new Netanyahu government would seek to limit the power of the Supreme Court to overturn laws passed by parliament and tighten controls over foreign donations to left-wing organizations.
Zeev Elkin, a Likud negotiator, said Bennett was demanding the justice minister portfolio for Jewish Home, a post critical to the smooth passage of cabinet-approved legislation to parliament for ratification.
"I think this is extortion, I have no other way of describing it," Elkin said on Army Radio. But political commentators predicted Netanyahu would bend.
The 14-day extension Rivlin granted Netanyahu to announce a new government, after an original 28-day period ran out, expires at midnight (2100 GMT).
Under Israeli law, Rivlin can then assign the task to another legislator, with Issac Herzog, leader of the center-left Zionist Union, the likely candidate.
A coalition pact between Netanyahu and Herzog would ensure a broad government, but the Zionist Union chief has not strayed from his post-election pledge to take to the opposition benches. (Editing by Luke Baker and Janet Lawrence)