The Maoist movement, formally called the Communist Party of Nepal, is calling for Madhav Kumar Nepal, the prime minister, to resign by the end of Saturday and disband the present government.
"If there is no agreement reached by Saturday, then we will be forced to impose an indefinite general strike from Sunday,'' Baburam Bhattarai, the deputy leader of the party, said.
Demonstrators waved red flags and chanted "dissolve this puppet government and set up a national government."
Shops and businesses were closed and residents were stockpiling food in fear that supplies might run short in the event of a national shutdown.
As demonstrators were massing for the rally, the Maoists were meeting representatives of other major parties to try to break the political impasse.
The protest and threat of a general strike has raised concern of renewed violence in Nepal.
Karin Landgren, the chief of United Nations peace mission in Nepal, said she had met Maoists leaders to appeal for peaceful resolution and had been assured Saturday's demonstrations would be peaceful.
"I am deeply concerned that despite these peaceful intentions, potential spoilers of the peace process could provoke a clash," Landgren said on Friday.
The Maoists fought government troops until 2006 when they gave up their
decade-old violent uprising and joined a peace process.
They briefly led a coalition government after winning polls in 2008, but resigned from government last year after the group's leader was prevented from dismissing the army chief.
The Maoists still hold the largest number of seats in parliament.