After being so tantalisingly close to starting negotiations two weeks ago, everything is in shambles. It is evident that both the government and the Maoists went into talks just to hoodwink the Nepali public into thinking that they were serious about a negotiated solution. As it turned out, neither side really wanted to talk. They just wanted to buy time: the Maoists to regroup, redeploy and launch the second phase of their struggle, and the government to get the necessary ordinance to set up a paramilitary force.

What a contrast to the euphoria that greeted the talks two weeks ago. Deputy Prime Minister Ram Chandra Poudel shook hands with a Maoist and decided he wasn't a monster. The government met the Maoist precondition by releasing Dinesh Sharma, but not before he renounced Maoism and un-renounced it some hours later. This was the perfect excuse for the Maoist leadership to cry foul and say the door to talks was "nearly" closed. The mediator, Padma Ratna Tuladhar, blames the government for poisoning the mood for talks. "There are some elements in government that don't want talks," he told us. For his part, Poudel thinks the Maoists were not serious, and were only engaged in a PR exercise. "The Maoists seem to want to use talks as a part of their strategy to regroup," he said.

Distracted by its own infighting and the need to deal with the moderate left, the ruling Nepali Congress says it has a "wait-and-watch" policy. But in actual fact it seems to have put the talks on the back burner. Prime Minister Girija Prasad Koirala has actively pursued getting royal approval for an ordinance to set up a well-armed paramilitary force to be carved out of the police and trained by the army. Legislation to set up the force through parliament would take too long. The ruling party is also putting final touches on a package programme for the development of 25 Maoist-affected districts to be administered by a special "security and development committee" patterned after the US Army's Internal Development and Defence (IDAD) strategy. The committee will be headed by the vice-chairman of the National Planning Commission and will consist of the Army and Police chiefs, the secretaries from the ministries of defence, home, and finance, who will work together to strategise and implement development programmes in the insurgency-hit areas.

In addition, the government is also setting up a special "Basket Fund" for the five worst-affected mid-western districts: Rukum, Rolpa, Jajarkot, Kalikot, and Salyan. The Rs 190 million fund will be administered by Poudel with the help of a co-ordination committee. Foreseeing Maoist resistance, the government says it also has a security plan to implement the programmes. That is, it will be guarded by a special police force, with the army standing by to provide backup support. But responding to the public opinion in favour of talks and international pressure, neither the Maoists nor the government have completely shut the door. One senior government official told us: "Even if Baburam (Bhattarai) wants to talk to the prime minister, we're ready."

The Maoist leadership want changes in the constitution's provisions for multi-party democracy and constitutional monarchy arguing that they are "contradictory, unscientific and reactionary". But both the Congress and the opposition UML have been maintaining that these are non-negotiable.

On the ground, the Maoists say they are now done with the first phase of "strategic defence" and have moved on to "power consolidation" which in turn will lead on to the "full-scale offensive" phase. Jargon aside, the Maoists have been busy carrying out arson attacks on police posts in the east, and firebombing industries and companies that have refused to pay their "tax".

It is certain the Maoists will not take too kindly to the government's "guns and packages" strategy of moving into their base areas. They will try to inflict maximum casualties on the paramilitary, and more importantly, capture their new semi-automatic rifles. Much more uncertain is how they will deal with the army, which is supposed to defend the police in case they are attacked.

So far, the Maoists and the Army have been fairly cosy with each other. The Maoists have not attacked facilities like telecommunications towers after they came under army protection. They've not attacked army road-builders in the mid-west. Also, there haven't been any skirmishes between the army and Maoists since soldiers were stationed in 16 district headquarters after the Dunai massacre in September, even though the soldiers patrol alongside the police.

But all this could change overnight. One senior army officer told us: "This is a potential Vietnam. The rules of engagement are too messy. The army should be the last line of defence, you can't use it piecemeal like this and risk getting into a quagmire."