* Coalition breaks up on reunification differences
* Makes consensus on fiscal reforms more difficult
* Resignation threatens to derail peace talks
(Adds comment from Turkish Cypriots)
By Michele Kambas and George Psyllides
NICOSIA, Aug 3 (Reuters) - The junior partner in Cyprus’s two-party coalition quit the government on Wednesday, making agreement on vital economic reforms more difficult and potentially complicating reunification talks.
The centrist Democratic Party, coalition partners with the Communist AKEL since 2008, said they were leaving government after exhausting all room for further cooperation.
“It is clear that the dialogue has been terminated and the Democratic Party ceases to be in cooperation with the president of the Republic,” said party leader Marios Garoyan.
Cyprus has a presidential system and the pullout is not seen as endangering the survival of incumbent President Demetris Christofias, whose term expires in 2013.
But passage of essential economic reforms largely depends on parliament, where Christofias’s party does not have a majority.
The reforms are urgently needed to tackle an energy crisis threatening to tip the island into financial meltdown.
“It’s disastrous,” said economist Fiona Mullen. “In order to to get agreement on fiscal reform you need at least two parties to get it through parliament. This makes consensus a lot less likely.”
The Central Bank and the island’s largest commercial bank have warned that Cyprus — which accounts for about 0.2 percent of the euro zone’s economy — could follow Greece, Portugal and Ireland in taking a bailout.
An accidental blast of decaying stored munitions that destroyed the island’s biggest power station last month greatly aggravated an already difficult fiscal situation.
Moody’s and Standard and Poor’s downgraded Cyprus’ sovereign rating last week, and borrowing costs of the euro zone minnow have soared, fuelling speculation it could be the fourth recipient of an EU bailout.
The pullout also weakens Christofias in peace talks on Cyprus, where the U.N. is attempting to broker a reunification deal between his Greek Cypriot side and Turkish Cypriots. Any deal has to be approved in a referendum.
Greek Cypriot approval for a deal, already in doubt, could be further complicated with a president weakened by the desertion of his political allies.
Coalition squabbling came into sharp focus after Cyprus was hit by the blast of confiscated munitions stored in scorching heat only a few hundred metres from the power station.
The Democratic Party, known as DIKO, had been a fierce critic of Communist Christofias’ tactics in talks on Cyprus, split in a Turkish invasion in 1974 after a brief Greek-inspired coup.
Their withdrawal comes at a time when the United Nations is cranking up reunification talks on the ethnically split island to mend a conflict harming Turkey’s EU ambitions.
The Turkish Cypriot side said they were concerned but hoped the situation would not damage the negotiations.
“We want our counterparts to be able to concentrate on the negotiations, which includes being able to engage in a give-and-take process and making mutual concessions,” said Kudret Ozersay, chief aide to Turkish Cypriot leader Dervish Eroglu.
DIKO, who take a harder line than Christofias in unification talks, had insisted that the president withdraw proposals made in the negotiations, including a suggestion that the Greek and Turkish communities share future governance via a rotating presidency and a weighted voting system.
They also opposed another proposal allowing up to 50,000 Turks who settled in Cyprus after 1974 to remain.
Greek and Turkish Cypriots have agreed in principle to reunite Cyprus under a two-zone, bi-communal federation. The United Nations wants a peace deal by next July, before the island assumes the EU rotating presidency. (Editing by Ingrid Melander and Barry Moody)