WASHINGTON, March 23 (Reuters) - U.S. lawmakers on Friday released $88.6 million in development aid for the Palestinians that they had held up since last summer, a move that should help ease a fiscal crisis in the aid-dependent Palestinian economy.

Representative Kay Granger announced she was ready for the entire $147 million in U.S. assistance that had been frozen since August to go to the Palestinians.

But the other Republican who had a "hold" on the funds, Representative Ileana Ros-Lehtinen, limited the release to $88.6 million, saying in a letter to Secretary of State Hillary Clinton that was all she was willing to free up.

Ros-Lehtinen also said she was releasing the money with the understanding it would not be used for "assistance and recovery in Hamas-controlled Gaza," West Bank road construction, or trade and tourism promotion in the Palestinian territories. The United States considers Hamas to be a terrorist organization.

The letter did not say how the freed-up funds would be spent, but Ros-Lehtinen suggested earlier this week she would be willing to approve money targeted for water programs, health and food for the Palestinians.

Both Granger and Ros-Lehtinen had barred expenditure of the U.S. funds since last year because they objected to the Palestinian push for recognition at the United Nations. They argued that the path to Palestinian statehood was through a peace treaty with Israel.

Granger said on Friday she had decided the money should be released for humanitarian reasons and to help stability in the Palestinian territories in a time of uncertainty across the Middle East.

"I have taken a strong position on aid to the PA (Palestinian Authority) to send a message that seeking statehood at the United Nations, forming a unity government with Hamas and walking away from the negotiating table with Israel were not pathways to peace," Granger said in a statement.

"Right now it is in our interest - and the interest of our allies in the region - to allow aid to flow to address security and humanitarian concerns."

Granger chairs the House of Representatives appropriations subcommittee in charge of foreign aid, while Ros-Lehtinen chairs the House Foreign Affairs Committee.

Technically, the Obama administration can override the objections of individual lawmakers and spend aid money once it has been appropriated by Congress.

But successive administrations have generally deferred to holds on funds by key members of relevant committees.

Ros-Lehtinen complained in her letter to Clinton and U.S. Agency for International Development Administrator Rajiv Shah that the administration had threatened to spend the money "over congressional objections" if the lawmakers' holds were not lifted.

"I am disappointed that the administration would employ hard-ball tactics against Congress," she said.

IMF URGES DONORS

Both Granger and Ros-Lehtinen have been pressured by the Obama administration as well as the international community to release the development aid, which Congress had appropriated for fiscal year 2011.

There have been growing warnings, including from the International Monetary Fund, that the Palestinians are facing a deepening financial crisis due to a drop in aid from Western backers and wealthy Gulf states as well as Israeli restrictions on trade.

The IMF urged donors last week to meet their aid pledges to the Palestinian Authority in the Israeli-occupied West Bank, which has a projected 2012 budget deficit of $1.1 billion.

The United States has committed over $4 billion in bilateral assistance to the Palestinians since the mid-1990s, the Congressional Research Service says.

Since fiscal year 2008, the annual U.S. contribution has averaged $600 million, the CRS says. Usually, that includes about $200 million in direct budgetary aid and $100 million in security aid for training Palestinian security forces, in addition to development aid, the CRS says.

Congress voted in December to allow aid to the Palestinians to continue in fiscal 2012 - the current fiscal year - as long as they were not admitted as a state to any more U.N. organizations. The Palestinians won admission to UNESCO in October, a move that prompted the United States to cut off funding to that agency.