* Party quits coalition, prime minister tenders resignation
* King is still considering his response
* Political paralysis could hurt economy
(Updates with parliament sittings suspended, king's audiences)
By Antonia van de Velde
BRUSSELS, April 22 (Reuters) - Belgian Prime Minister Yves Leterme's government collapsed on Thursday after the Flemish liberal party pulled out of his five-month-old coalition, causing a crisis that could damage its fragile economy.
Leterme, 49, tendered his government's resignation to King Albert after an emergency cabinet meeting, but the monarch did not immediately decide whether to accept it.
"The king and the prime minister jointly underlined that, in the current circumstances, a political crisis would be inopportune and would seriously damage both the economic and social well-being of the citizens and the role of Belgium in Europe," the palace said in a written statement.
Political analysts said Leterme might be persuaded to stay on. Otherwise parliament would have to be dissolved and an election held within 40 days.
The king later consulted the speakers of the lower and upper houses of parliament and was expected to receive the heads of Belgium's mainstream parties.
Sittings in the lower house, which was due to vote on a bill to ban wearing the burqa in public on Thursday, was suspended until next week.
Without the backing of the centre-right Open VLD, the remaining four parties in government still had 76 of the 150 seats in the lower house of parliament but the coalition would have found it hard to govern with such a slim majority.
Open VLD said it had lost faith in the government, which groups parties from centre-left to centre-right, because it had failed to resolve a dispute between French- and Dutch-speaking parties over electoral boundaries around the capital, Brussels.
"We have not agreed on a negotiated solution and therefore Open VLD no longer has confidence in the government," said Alexander De Croo, the party's chairman.
Economists have expressed concern that political paralysis in the linguistically-divided country of 10.6 million people as it recovers from the global economic crisis would harm the prospects of reducing Belgium's budget deficit.
The government forecasts the deficit will be 4.8 percent of gross domestic product in 2010, and Belgian debt is expected to exceed 100 percent of GDP this year.
The premium investors demanded for holding Belgian debt increased on Thursday. The spread between 10-year Belgian bonds and German bunds had widened to a four week high of 51 basis points from 43 at Wednesday's close, although this was in line with a widening trend for other euro zone sovereign bonds.
"Until now we may say that Belgium was off the radar screen of the financial markets, but this political crisis could bring Belgium back on to the radar screen of those shorting debt markets, speculators or otherwise," said Etienne de Callatay, economist at Bank Degroof in Brussels, referring to the practice of trying to profit from a decline in an asset's value.
Leterme became prime minister for a second time last November when Herman Van Rompuy left the post to become president of the European Union.
Even at the start of his second term, political and economic analysts said they were worried it could prove as unstable as his first nine months in power in 2008, when Belgium lurched from one crisis to another.
Leterme's nine-month struggle to form his first government fuelled concerns in the media at the time that Belgium could break apart and raised the risk premium investors demanded to hold government bonds.
Belgium, home to European Union institutions and the NATO military alliance, will not want to let domestic problems drag on because on July 1 it takes over the six-month EU presidency, an organisational role held by each member state in turn.
"It's very embarrassing and it's an embarrassment on top of a previous embarrassment," said Carl Devos, politics professor at Ghent University.
For a factbox on the crisis, double-click on [ID:nLDE63L0HR]
For facts about Leterme, double-click on [ID:nLDE63L1BS]
For a snap analysis, double-click on [ID:nLDE63L1HO] (Additional reporting by Luke Baker and Ben Deighton, writing by Philip Blenkinsop, editing by Diana Abdallah)