* Economy minister says Palestinian state would crush Israel
* Business leaders urge peace deal, head for Davos
* Diplomats warn of growing economic boycotts for Israel
By Crispian Balmer
JERUSALEM, Jan 20 (Reuters) - Economy Minister Naftali Bennett dismissed on Monday a growing chorus of alarm that Israeli business will face international isolation if peace talks with the Palestinians fail.
Indicating rising friction within the government, Bennett urged Prime Minister Benjamin Netanyahu to ignore the warnings, saying an independent Palestine would become a haven for militants and represent a serious threat to Israeli stability.
"A Palestinian state would crush Israel's economy," Bennett told supporters of his right-wing nationalist 'Jewish Home' party that has threatened to quit Netanyahu's coalition if peace negotiations progress.
Bennett's dire vision came on the day a group of prominent Israeli and Palestinian corporate leaders said they would fly to the Davos World Economic Forum this week to throw their weight behind U.S. efforts to secure an unlikely peace accord.
Itamar Rabinovich, a former ambassador to Washington and a member of the Israeli-Palestinian 'Breaking the Impasse' group, said the business community recognised the potential rewards to be reaped if the talks succeed, and the risks posed by failure.
"A deal would mean Israel could invest less in defence and would open up huge economic opportunities with the Arab world," he told Reuters. "But an economic boycott and loss of international legitimacy is undoubtedly a major threat."
Direct peace talks aimed at ending the decades-old Middle East conflict resumed last July, and have reached a critical moment, with U.S. Secretary of State John Kerry trying to draw up a framework deal meant to open the way to a final accord.
Kerry, who has visited the region 11 times in less than a year in his drive to bridge the divisions, is due to meet Netanyahu in Davos later this week.
More moderate members of the coalition government have warned of catastrophe if Netanyahu, whose party is openly sceptical about the talks, walks away from the table.
"The negotiations are the wall stopping a wave (of economic boycotts) right now," said Justice Minister Tzipi Livni, who heads the Israeli negotiating team.
Interviewed on local television at the weekend, Livni was asked if Israel faced the sort of isolation imposed on South Africa during the years of apartheid. "Yes," she said.
Companies in Israel's largest economic partner, the European Union, have already started to signal their concern.
One of the largest pension funds in the Netherlands, PGGM, announced earlier this month that is was divesting from five Israeli banks because of their business dealings with Jewish settlements that dot the occupied West Bank and East Jerusalem.
A Scandinavian diplomat in Jerusalem said representatives from two major Nordic investment companies had recently visited Israel to discuss their concern over businesses tied to settlements and were considering pulling funds.
Another Western diplomat said EU leaders were passing on the message to Netanyahu.
"The spectre of (economic) boycotts is out there. We are telling Israel we are against boycotts, but we are flagging the spectre of isolation. This is a nightmare vision for them," said the senior diplomat, who declined to be named.
Bennett acknowledged seeing the "buds of economic boycott", but said an independent Palestine represented a far greater threat because it would become a launch pad for attacks.
"We need to raise our head, stop being scared," he said.
"We know how to fight back. We fought against terror, and we won. We fought against conventional wars, and we won. Now there is a new kind of war, of delegitimisation against the state of Israel ... and we need to fight back and win." (Additional reporting by Ari Rabinovitch and Maayan Lubell; Editing by Robin Pomeroy)