The United States should penalise Israel by withholding from its annual aid a sum equal to the amount Israel gives in subsidies to West Bank settlements, Human Rights Watch (HRW) said on Sunday.

In a 166-page report, the group called on the international community to penalise Israel for "discrimination" in the West Bank, comparing the services enjoyed by Jewish settlers with those of neighbouring Palestinian villages.

"Palestinians face systematic discrimination merely because of their race, ethnicity, and national origin, depriving them of electricity, water, schools, and access to roads, while nearby Jewish settlers enjoy all of these state-provided benefits," HRW representative Carroll Bogert said.

"While Israeli settlements flourish, Palestinians under Israeli control live in a time warp - not just separate, not just unequal, but sometimes even pushed off their lands and out of their homes."

The group called on the international community to avoid complicity in Israeli breaches of international law by going as far as holding back assistance to the Jewish state.

"The United States, which provides 2.75 billion dollars in aid to Israel annually, should suspend financing to Israel in an amount equivalent to the costs of Israel's spending in support of settlements, which a 2003 study estimated at 1.4 billion dollars," the report said.

"Similarly, based on numerous reports that US tax-exempt organisations provide substantial contributions to support settlements, the report urges the US to verify that such tax-exemptions are consistent with US obligations to ensure respect for international law," it added.

Jewish settlement on occupied Palestinian land is one of the most divisive issues in efforts to forge a peace agreement between the two sides.

Around 500,000 Israelis live in more than 130 locations across the West Bank and east Jerusalem - territories occupied by Israel in the 1967 Middle East war but claimed by Palestinians for a future independent state.