Settlement activity in the occupied West Bank must stop at once if there is to be any prospect of reaching a two-state peace agreement with Israel, the Palestinian prime minister has warned in a Guardian interview.

Salam Fayyad said he found it "devastating" that Israelis were not even debating the settlement issue in their election campaign. He warned that Palestinian support for his policy of reform and negotiation would collapse if prospects for a workable deal faded away.
Palestinian PM Salam Fayyad talks to Ian Black Link to this audio

Speaking before talks with Gordon Brown this morning, Fayyad dismissed as "naive" calls by Binyamin Netanyahu, leader of Israel's rightwing Likud party, for an "economic solution" to the conflict with the Palestinians. Polls show Netanyahu beating Kadima's Tzipi Livni ahead of February's election.

Policy towards Israeli settlements will be a "litmus test of seriousness" for the US president-elect, Barack Obama, he predicted. George Bush controversially gave Israel the go-ahead to keep settlements beyond the 1967 borders.

Fayyad criticised the EU for missing an opportunity to encourage Israeli voters to debate illegal settlements by failing last week to make a key agreement with Brussels conditional on a change of policy.

"It is of critical importance that settlement activity stop and stop promptly," he insisted. "The one issue that really has the greatest bearing on a two-state solution, settlement activity, is not a matter of public debate in Israel.

"There is a worrying disconnect between what's going on in the run up to the Israeli election and what the next government will have to contend with. None of the major party candidates are having to address this. This is going to be a serious complication – whoever wins."

Fayyad, 56, has served as interim prime minister under the Palestinian president, Mahmoud Abbas, since the Hamas takeover of the Gaza Strip in June 2007. The former World Bank economist is highly regarded in the west for having launched economic and security sector reforms – though these are confined to the West Bank. Gaza, home to 1.5 million Palestinians, remains under siege.

Fayyad refused to endorse Livni over Netanyahu but said in an unmistakeable reference to the views of the Likud leader: "Ours is a political conflict, not an economic one. Given my background there is no way I would say economic development is unimportant. But to think it is a substitute for the heavy lifting that has to occur on the political track is naive. Economic peace won't cut it."

Fayyad, in London for an investment conference, called on the international community to demand greater "accountability" having invested record sums in Palestinian development since the 1993 Oslo agreement but seeing no progress since the Annapolis summit a year ago.

"Settlement activity that was supposed to stop completely after Annapolis has accelerated by every indicator," he said. "Rather than preoccupying myself with who is going to win [the Israeli election] what I lament is that this is not an issue of debate. It is alarming, worrying, devastating. I feel very strongly about this."

Land confiscations and the "separation wall"– billed by Israel as a defence against suicide bombers but perceived by Palestinians as another land grab – were casting doubts over the very viability of a Palestinian state, he said.

"Where exactly is this state going to emerge if Israel continues with its settlement enterprise? That's why this issue is of paramount importance. It's basic. The territory keeps on being eaten up and broken up into cantons and enclaves," he said.

"I do not know when this conflict is going to be resolved. I care more about whether sufficient effort is being made to ensure that the requirements of success are being taken care of. The bigger question is:, when we get to that station will there still be a train to take?

"The message to our people is that we need to do everything we can to help ourselves. Our programme is to end the occupation and have our state. But, first things first, we need to build strong institutions and a functioning economy – even under occupation. We cannot wait until it all ends. With each passing day that settlement activity continues, more and more people will question this doctrine. And the hole in this argument keeps growing bigger.

"The question I have to answer is exactly where the state is going to emerge. That is why it is critically important that settlement activity stop and stop promptly.

"We need to be assured that when we are done there is going to be room for the independent sovereign viable Palestinian state. Otherwise the charge is going to be that we are not engaging in an effort to end the occupation but make it work better or to beautify it."Fayyad said he was open to dialogue with Hamas but regretted that it failed to attend recent reconciliation talks in Cairo. "The siege has never been tighter. The misery index has never been higher. This is not a sustainable situation"

Palestinians needed a "non-factional" government of national consensus and transitional Arab guarantees to manage security in Gaza until Palestinian forces could take over again, Fayyad said. "We need to put the country back together. But it is only going to happen politically."