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By Mike Collett-White

ISLAMABAD, Aug 6 (Reuters) - Former Prime Minister Benazir Bhutto said on Tuesday she would defy a ban on her participation and contest Pakistan's general elections in October -- even if it meant doing so from a prison cell.

In a telephone interview from self-imposed exile in London, the 49-year-old told Reuters: "I am returning to contest the next election."

"I would like to contend. My party wants me to contend. The people want me to contend. But I am being stopped by a general who seized power in a coup who happens to be a key ally to the West."

President Pervez Musharraf, who ousted Bhutto's successor Nawaz Sharif in a bloodless coup in 1999, has decreed that prime ministers who have served twice cannot run for a third term, a move that excludes both ex-premiers from resuming power.

They are also both disqualified under a rule banning people convicted of crimes.

Bhutto argues that the charges of corruption against her are pending, and that a third hurdle -- banning anyone who failed to turn up in court to face charges as she did earlier this year -- was also illegal, as she was represented by her lawyer.

"He promised a fair election and he's done everything in his power to ensure a pre-determined result."

Bhutto still enjoys strong support in Pakistan. Her participation, or even arrest, could enhance her political party's chances of success, analysts say.

The Pakistan People's Party (PPP) of which Bhutto is head, formed a new group called PPP Parliamentarians on Monday, just in time to meet the deadline by which parties had to complete internal elections to qualify for the parliamentary polls.

Bhutto would remain chairperson of the original PPP, but it would not contest the vote and she would hold no official position in the new movement.

BENAZIR BOWS OUT?

Local media speculated that the move signalled a dignified exit by Bhutto from the election and a victory for Musharraf.

Sharif handed over the helm of his Pakistan Muslim League (PML) party to his brother, also in order to sidestep the decrees and proposed constitutional amendments blocking him.

But Bhutto denied the decision signalled her demise.

"This decision has been made because of the hurdles that have been placed to the democratisation of Pakistan," she said.

"I'll come back to contest the election," she said. "So what if I'm arrested? I can contest the elections from prison. I can win from prison. Putting the front-runner of the election in prison exposes the regime still further."

Police in the key eastern city of Lahore have promised to arrest Bhutto should she try to return.

She confirmed that she would fly into Lahore, the scene of a tumultuous welcome in 1986 -- the last time she returned from exile to challenge the then military ruler Zia-ul-Haq.

Bhutto's greeting this time around would be more low key, analysts say, because she and her family have been tainted by corruption scandals during her two terms in office. Some doubt she will risk coming back at all.

But others argue it is too early to write her political obituary. The daughter of Pakistan's first elected prime minister knows all about adversity.

Both times she was in power she was sacked by the president on charges of corruption. Her father, Zulfiqar Ali Bhutto, was ousted in a military coup by General Haq in 1977 and later hanged for conspiracy to murder.

Bhutto herself endured long periods of political imprisonment in the late 1970s and early 1980s.

She said that she would seek to overturn Musharraf's moves against her in court so she could contest the election legally, but was working on alternative strategies if that failed.

Bhutto said Musharraf was using his position as a key ally to the United States in its fight against al Qaeda and the Taliban in neighbouring Afghanistan to enhance his own powers without serious criticism or scrutiny.

Musharraf extended his rule by five years in a referendum in April and has proposed constitutional amendments which would empower him to dissolve parliament, sack the prime minister and fire the cabinet.

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