Ariel Sharon stepped in to block defence cuts

The 10bn shekel ($2.2bn; �1.4bn) cutback takes the government's 2004 budget to 257bn shekels.

The move, agreed on Tuesday morning after a marathon 18-hour meeting, follows a similar belt-tightening exercise for the current financial year.

But the cuts have triggered deep divisions within the cabinet, as a phalanx of powerful ministers - backed by Prime Minister Ariel Sharon - forced Finance Minister Benjamin Netanyahu to scale back much of his plans to slash the defence budget.

The burden is to fall instead on welfare and education.

And the new spending plan still has to pass three votes in the Knesset, or parliament - a process that held up last year's budget for weeks.

In the meantime, Israel's economy remains in a parlous state, gripped by a three year recession which has coincided with ballooning security spending in the face of bloody conflict with the Palestinians.

The effect has been to squeeze tax revenues and inflate the budget deficit to as much as 6% this year.

For 2004, the government is basing its projections on 2.5% growth and a 4% deficit - described by credit agencies as a tough target.

Jockeying for position

Originally, Mr Netanyahu had planned to cut defence by as much as 3bn shekels.

Defence spending is seen by Sharon as sacrosanct

But But defence Minister Shaul Mofaz made sure that the prime minister - a former general - was onside to prevent that, and Mr Netanyahu transferred much of the burden to an across-the-board 5% fall in national insurance payouts instead.

Mr Mofaz still voted against the budget's lower defence spending cutback, along with eight others in the 23-member cabinet.

Among them were the five ministers from the secular Shinui party, demonstrating the split in Israel's polity caused by the government's need for minority party support.

Without the votes of the ultra-Orthodox Jewish parties, the Likud party government of Mr Sharon cannot hold a majority.

The Shinui ministers are angry that Mr Netanyahu refused to cut back on subsidies to religious councils and the services they deliver, although they have stepped back from threats to collapse the coalition over the issue.

Vice Premier and Industry, Trade and Labour Minister Ehud Olmert also voted against the budget, having told Mr Netanyahu over the weekend that the plan failed to do anything to encourage growth and employment, both stagnant at best.