The Palestinian foreign minister is denying reports he might accept a two-state solution with Israel. The new Hamas government held its first cabinet meeting to discuss the growing financial crisis in the Palestinian territories.

Controversy deepened over comments by Palestinian Foreign Minister Mahmoud Zahar, considered a hardliner in the Hamas Islamic-militant group.

Tuesday, Mr. Zahar sent a letter to U.N. Secretary-General Kofi Annan. News reports quoted the letter as saying Palestinians were seeking a "two-state solution," to the Israeli Palestinian dispute. But Wednesday, Mr. Zahar angrily denied making such reports, which were first reported by the French news agency, AFP.

Mahmoud Zahar (File photo)

Zahar says the AFP report is completely false, and he never made any such statement.

In his letter to the U.N. Secretary-General, Zahar said Palestinians want to live "side-by-side" with their neighbors - presumably Israel. But, he says Israel's expansion of settlements in the West Bank and the construction of a controversial security barrier will in "ultimately diminish any hope" of achieving peace based on "a two-state solution," to the Israeli Palestinian dispute.

Hamas refuses to recognize Israel, disarm or recognize previously signed agreements between Israel and the Palestinians. Hamas is regarded as a terrorist organization by Israel, the United States, and the European Union.

Ismail Haniyeh (File photo)

Meanwhile, Palestinian Prime Minister Ismail Haniyeh, who is also a senior member of Hamas, presided over the first full Cabinet meeting of the new Palestinian government. Haniyeh told his colleagues that the Palestinian Ministry of Finance has virtually no money to pay the estimated 140,000 Palestinian civil servants.

The transfer of tax and customs revenue collected by Israel and turned over to the Palestinian Authority was suspended by Israel recently, and other international donor assistance has also been suspended because of the Hamas refusal to recognize Israel.