Like other Arab citizens of Israel, Leyla Ahmoud is anxious about her future. A young mother of two girls with another on the way, Ahmoud says recent moves by the Israeli government are making it increasingly obvious that the Arabs are not welcome in their own country.

"I feel like my life is not in my hands," said 24-year-old Ahmoud, who lives in Umm al-Fahm, a mountain-ridge town of some 43,000 inhabitants in northern Israel. "The government decides how I live and where I live. We exist in fear, from one day to the next."

Israel's prime minister, Binyamin Netanyahu, famously referred to Arab citizens of Israel, who make up a fifth of the population, as a "demographic bomb" in 2003. His cabinet recently passed a new citizens bill that, if approved, will require all non-Jewish migrants to pledge loyalty to Israel as a "Jewish and democratic state" – although, apparently in response to international pressure, the law may now be amended to apply to all new migrants, including Jews.

The Association for Civil Rights in Israel (ACRI) points to a string of other laws in the pipeline that would require individuals from parliamentarians to film crews to swear their allegiance. During the latest round of peace talks, Netanyahu reiterated that the Palestinian Authority should recognise Israel as a Jewish state – again signalling the preference for an ethno-religious Israel rather than a state for all its citizens.

Just weeks ago, Israeli forces staged a training exercise to test the state's response to a potential revolt among its Arab citizens if a peace agreement involved their forced transfer to a new Palestinian state. In a comprehensive security drill, forces practised anti-riot tactics and established two detention centres to accommodate prisoners.

Israel's extreme-right foreign minister, Avigdor Lieberman, has ratcheted up talk of a population exchange with the Palestinian Authority, whereby illegal settlements in the occupied West Bank would become part of Israel while Arab towns such as Umm al-Fahm, in the northern area bordering the West Bank, would be turned over to a new Palestinian state.

Today in Umm al-Fahm, where the loyalty oath is referred to as "Lieberman's law", there is a sense of living inside a paradox. "On the one hand, the state is saying to us that, as Arabs, we are a danger and not welcome here," said Said Abu Shakra, the director of Umm al-Fahm's art gallery. "But on the other hand, we are constantly asked to prove our loyalty to the state."

While supportive of the Palestinian struggle for statehood, this population - which identifies itself as Palestinian-Arab or Palestinian-Israeli - has repeatedly indicated its wish to retain Israeli citizenship. Its struggle is for equality.

"Where else would I go? My life, my children, my future is here," said one 28-year-old mother of two, who did not wish to be named. "I don't have another place, but what can we do to stop it if they [Jewish Israelis] are the strong ones?" Residents of Umm al-Fahm, which is thought to date back to 1265, talk of family roots in the area stretching back hundreds of years.

"We find ourselves thinking about these things now," 50-year-old lawyer Adnan Asad said of a possible population exchange. "I think, if you do transfer us, just do it when the kids are still young so that they might have a change to adapt. We're making jokes about what we'll sell when we become the street traders from the Palestinian state that stand at Israeli junctions."

Recent developments have drawn protest from some Israelis who say they are alarmed by their government's "anti-democratic" and "fascist" legislation. ACRI has asked the prime minister to make clear that there are no transfer plans on the negotiating table, and l ast weekend, thousands demonstrated agaisnt the policies in Tel Aviv. Speaking at the protest, Knesset member Dov Khenin, of the leftwing Arab-Jewish party Hadash, warned: "The population transfer has turned from a nightmare into an operational plan."

In Umm al-Fahm, Israel's second largest Arab town, residents believe the policies aren't just bad for the Arab minority but for the entire Israeli population.

Abu Shakra said he had worked to further dialogue between Jews and Arabs in Israel in Israel for 15 years – but that the government now seemed intent on making this untenable. "They are looking for ways to provoke conflict, not to create dialogue or equality," he said. "After 60 years, it is time they embraced the Arab population and understood that if things are not good for Arabs in Israel, they won't be good for anyone."