The walkout by the far-right Lieberman raised the prospect that Netanyahu, whose conservative Likud party won the most votes in a March 17 election, may have to settle for a narrower alliance to secure a majority in the 120-seat parliament.
That could hobble the fourth-term premier, whose domestic policies are often resented at home while his championing of Israeli settlement in the occupied West Bank and East Jerusalem, lands the Palestinians seek for a state, is opposed abroad.
Netanyahu could ask the leading center-left opposition party Zionist Union to join forces in a “national unity” government, though both sides have so far played down any such possibility.
Briefing reporters, Lieberman said his party had been offered two cabinet posts as part of the coalition talks but remained unsatisfied.
“This is certainly a coalition that, to my regret, does not reflect the positions of the nationalist camp and is not to our liking, to put it mildly,” said Lieberman, adding that he was resigning as foreign minister.
Netanyahu last week signed up his first new coalition partners, the ultra-Orthodox United Torah Judaism (UTJ) party and centrist Kulanu, giving him control of 46 parliament seats.
Likud is still negotiating with the far-right Jewish Home and ultra-Orthodox Shas parties.
Lieberman’s Yisrael Beitenu party draws support from Israelis who immigrated from the former Soviet Union and has often come out against benefits for ultra-Orthodox constituents.
Lieberman also complained that legislation anchoring in law Israel’s identity as a Jewish state, which had been advanced by the outgoing government, was being played down in the current coalition talks.
Shelly Yachimovich, a senior Zionist Union lawmaker, did not rule out her party joining Netanyahu but said it appeared unlikely.
“I don’t see an option like this,” she told Israel’s parliamentary television station. “It would be silly of me to consider something that does not exist.”
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