U.S. Secretary of Defense Donald Rumsfeld met Iraq's Shi'ite-led government on Wednesday after his top general in the country told him Shi'ite "death squads" were fuelling a surge in communal bloodshed.

Secretary of Defense Rumsfeld speaks during a news conference in Kabul July 11, 2006. [Reuters]

Shi'ite Prime Minister Nuri al-Maliki told lawmakers Iraq had one "last chance" to avert a slide to all-out civil war.

Several hours after he spoke, clashes erupted between gunmen armed with rocket-propelled grenades and police and residents in Um al-Maalif, a mainly Shi'ite neighbourhood in southern Baghdad. Police said there were a number of casualties.

Soon after Rumsfeld arrived in Baghdad, a suicide bomber blew himself up in a restaurant, killing seven people, police said. Security forces also found the bodies of 24 bus drivers who had been kidnapped earlier in a town north of Baghdad.

Major General Ghassan al-Bawi, the police chief of Diyala province, blamed insurgents for the kidnappings and said they were aimed at "inflaming" tensions between Shi'ites and Sunnis. Ten of the drivers were Sunni, the rest Shi'ite, he said.

Maliki told parliament Iraqi security forces had defeated a coordinated attempt by gunmen to occupy Baghdad districts west of the Tigris. Gunmen have fought in the streets and battled security forces in several districts in the past few days. Scores of people, mainly civilians, have been killed.

Maliki said a national reconciliation plan he has promoted was Iraq's "last chance" to stem the violence.

"If it fails, I don't know what the destiny of Iraq will be," he told the assembled Iraqi lawmakers, including representatives of the minority Sunni community who had staged a week-long boycott in protest at the kidnapping of a colleague.

The U.S. commander in Iraq, General George Casey, said Sunni militants in al Qaeda were stoking the sectarian violence that pits majority Shi'ites against the once-dominant Sunni minority.

"What we are seeing now as a counter to that are death squads, primarily from Shi'ite extremist groups that are retaliating against civilians," he told reporters.

"So you have both sides now attacking civilians. And that is what has caused the recent spike in violence here in Baghdad."

U.S. commanders have often been careful not to label gunmen as Shi'ites, although many of the recent attacks in Baghdad neighbourhoods have been blamed by Sunnis and police on the Mehdi army militia controlled by Shi'ite cleric Moqtada al-Sadr.

Sadr and his followers vigorously deny the accusations.

BIGGEST CHALLENGE

U.S. envoy Zalmay Khalilzad said sectarian violence was now the main challenge to the security forces, overtaking the three- -year-old Sunni insurgency as the biggest source of instability.

"A year ago, terrorism and the insurgency against the coalition and the Iraqi security forces were the principal sources of instability," Khalilzad said on Tuesday. "Violent sectarianism is now the main challenge."

As a result, the U.S. military is adapting its tactics to focus more on containing the sectarian violence, but Rumsfeld cautioned that the "solution is not military".

"We're at a point now when the security situation depends as much on the reconciliation process and on the strengthening of (government) ministries," Rumsfeld told reporters.

Maliki has offered talks with some Sunni rebels and a limited amnesty under his 24-point plan in a bid to draw Sunnis, the seat of the insurgency, closer into the political process.

Rumsfeld's trip also comes amid growing anti-war sentiment among the U.S. public in a congressional election year. A 129,000-strong American force is serving in Iraq more than three years into the war in which about 2,500 U.S. troops have died.

The defence secretary said it was too early to talk about adjusting U.S. troop levels. "We haven't gotten to that point."

Rumsfeld said he did not plan to discuss a series of inquiries in which U.S. soldiers are suspected of killing Iraqi civilians. These would be handled by the U.S. military, he said.

The cases have led Maliki to call for a review of foreign soldiers' immunity from Iraqi courts.