Palestinians may have to abandon the goal of an independent state if Israel continues to expand Jewish settlements in the occupied territories, the chief Palestinian negotiator has said.

Speaking to reporters in Ramallah on Wednesday, Saab Erekat said it may be time for Mahmoud Abbas, the Palestinian president, to "tell his people the truth, that with the continuation of settlement activities, the two-state solution is no longer an option".

Israel has rejected the idea of a de facto annexation of the occupied West Bank, incorporating the Palestinians as citizens, as a "demographic timebomb" that would make Jews the minority.

Citing a 2003 peace "road map", Abbas has made a cessation of Israeli settlement activity in the West Bank a precondition for resuming statehood talks with Israel.

Clinton called the settlements illegitimate after talks with Hosni Mubarak, the Egyptian president, in Cairo.

"We do not accept the legitimacy of settlement activity and we have a very firm belief that ending all settlement activity, current and future, would be preferable," Clinton said.

"Getting into final status negotiations will allow us to bring an end to settlement activity."

'Unprecedented offer'

Erekat said Clinton – who had earlier praised as "unprecedented" Netanyahu's August offer to temporarily limit construction of West Bank settlements - was only opening the door to more settlements in the next two years.

The alternative left for Palestinians is to "refocus their attention on the one-state solution where Muslims, Christians and Jews can live as equals", Erekat said.

"It is very serious. This is the moment of truth for us."

Erekat said Netanyahu's concept of a separate Palestinian state alongside Israel with limited powers of sovereignty, and his uncompromising position on the future of Jerusalem were tantamount to dictating the terms of peace negotiations.

Netanyahu, Erekat said, had told the Palestinian president "that Jerusalem will be the eternal and united capital of Israel, that refugees won't be discussed, that our state will be demilitarised, that we have to recognise the Jewish state, that it's not going to be the 1967 borders, that the skies will be under his control".

"This is dictation and not negotiations," he said.

Netanyahu and Abbas last met in New York in September in a handshake meeting arranged by Barack Obama, the US president.

Palestinians seek to establish the West Bank and Gaza as the territory of a Palestinian state, with East Jerusalem as its capital, based on borders set before Israel captured land from Jordan and Egypt in its 1967 six-day war.

"Anything short of that is a non-option for us," Erekat said.

No freeze

While Netanyahu's stated plan would place a freeze on new settlements in the occupied West Bank, no Israeli restrictions would be placed on 3,000 buildings already under construction.

"If the Israelis believe they want to partition the West Bank with us, this is a no-go. This is a non-starter," Erekat said, in reference to Israeli control of West Bank settlements, adjacent land, and the territory's eastern Jordan Valley border.

Clinton reaffirmed in Cairo on Wednesday that Washington does not accept the legitimacy of the Israeli settlements. But she added, in another nudge to Palestinians to talk with Israel: "Getting into final status negotiations will allow us to bring an end to settlement activity."

Erekat said Palestinians had "made a mistake" in the past by agreeing to negotiate with Israel without insisting on a settlement halt, and they were not about to repeat that error.

Clinton had earlier attempted to clarify her remarks on Washington's view of Netanyahu's plan.

"It is not what we would want and it is nowhere near enough – but I think that when you keep your eye on what we want to achieve, it is a better place to be than the alternative, which is unrestrained," she told Al Jazeera on Tuesday.

Israel's settlement building programme is illegal under international law and several United Nations Security Council resolutions have called for it to stop.

But Israel has repeatedly ignored all international calls for it to halt the construction.