* Report cites "enhanced international scrutiny" of Asmara
* Red Sea state accused of arming Somalia, Ethiopian rebels
* Government denies charges, blames US 'smear campaign'
Eritrea has reduced its support for the al Qaeda-allied al Shabaab militant group in Somalia under international pressure, but still violates U.N. Security Council resolutions and remains a destabilising influence, a U.N. report says.
The U.N. Monitoring Group on Somalia and Eritrea, which investigates violations of an arms embargo on both nations, said in a report to the Council, seen by Reuters, that it had found no evidence of direct Eritrean support for al Shabaab in the last year.
The Council imposed the embargo on the tiny east African state of Eritrea in 2009 over concerns its government was providing finance and weapons to al Shabaab - charges Asmara denied. The Monitoring Group now says that support has evaporated.
This was "a symptom of growing friction between the authorities in Asmara and al Shabaab's leadership" as well as the "result of enhanced international scrutiny, which has made direct support ... a much riskier undertaking than in the past", said the report, which is scheduled to be published this week.
"Although it is possible that the Eritrean authorities have continued to provide financial and other forms of assistance to (Somali) armed opposition groups, without their activities being detected, it is the Monitoring Group's assessment that any such assistance is negligible," the report said.
Instead, the panel presented evidence that Asmara deployed Ethiopian rebel groups via Somalia, sold weapons to smuggling rings in Sudan that do business with Palestinian arms dealers, and imported spare parts for its air force.
The report also alleged that ethnic Afar rebels responsible for the killing of five European tourists in eastern Ethiopia in January were hosted and trained in Eritrea, though there was no evidence the Red Sea state had a direct role in the killings.
It said the escape last year of Djiboutian prisoners of war held in Eritrea proved Asmara had violated a U.N. resolution calling on it to disclose information on their whereabouts after their capture following a border clash in 2008.
"Eritrea has failed to comply with Security Council resolutions and remains a destabilizing influence across much of the region," the report said.
The Red Sea state has previously rejected these allegations and has called for the replacement of the panel's members over what it calls their bias in favour of its arch-foe Ethiopia. Eritrean envoys to the AU declined to comment specifically on the latest U.N. report.
Al Shabaab has controlled much of southern Somalia since 2007, imposing a strict version of Islamic law in areas under its control. But over the last year it has been forced out of the Somali capital Mogadishu and other parts of the south by the coordinated military operations of U.N.-backed African troops.
"TOO EARLY TO LIFT SANCTIONS"
Last year, the Monitoring Group alleged Eritrea was behind a failed plot to bomb an African Union summit in Ethiopia, had bankrolled known members of al Shabaab in Kenya and had been involved in the smuggling of weapons through Sudan and Egypt.
As a result, the Council prolonged the arms embargo and assets freeze on Eritrea, in addition to a travel ban on some officials, amid an escalation in operations against al Shabaab by AU, Kenyan and Ethiopian troops and their Somali allies.
Matthew Bryden, the Monitoring Group's coordinator, told Reuters that Eritrea was lobbying its allies at the Security Council to push for a removal of the arms embargo, but he said other Council members were reluctant to do this.
"We're trying to make the case that any improvement in Eritrea's conduct is the result of sanctions, and that it's too early to lift them because of the other violations they have committed," Bryden said.
Earlier this month, the U.S. Treasury Department issued sanctions against Colonels Tewolde Habte Negash and Teame Abraham Goitom, two senior Eritrean military officers Washington says have worked closely with al Shabaab in the past.
Diplomats at the U.N. say the U.S. move against the two officers, who have not been subject to full Security Council sanctions, suggests that Eritrea will face sustained pressure from the United States and its allies in the Council.
Eritrean officials routinely deny involvement in Somalia and say the Council embargo decision was based on "fabricated lies" made up by the U.S. government and its ally Ethiopia.
In a letter obtained by Reuters in December, Eritrean Foreign Minister Osman Saleh accused the U.N. panel of bias and urged the Council's chair to establish an "independent, impartial and credible body".
TAXES, TRAFFICKING AND GOLD REVENUES
European and North American governments have also been concerned about Eritrea's use of revenues from the taxation of Eritrean citizens in the diaspora, from human trafficking of refugees through Sudan and Egypt, and from gold mining.
The Monitoring Group reported that both the British and German governments had taken action to prevent taxes being collected from diaspora Eritreans in their territories, in which Eritrean government agents often use coercion.
"Individuals who refuse to make payment may have their inheritance rights voided, their family members may be penalized, and they may be subject to detention or denial of an exit visa if they return to Eritrea," it said.
Asmara denies coercing its citizens, but insists it has the right to encourage its diaspora to contribute to the national budget, including for defence.
The report said Eritrean officials involved in the smuggling of weapons through Sudan and Egypt were also part of a people trafficking network that delivered tens of thousands of Eritrean refugees to Israel between 2009 and 2011.
Refugees interviewed in Israel said they were smuggled through Sudan by ethnic Rashaida gangs which the Monitoring Group says work with General Tekle Kiflai, the commander of Eritrea's western military zone.
Asmara says its fleeing nationals, often escaping unlimited military conscription, were being lured to leave the country by sustained American "propaganda".
The panel also urged the U.N. Security Council to consider measures to regulate Eritrea's opaque gold mining sector, which it said has generated hundreds of millions of dollars.
The Monitoring Group recommended that the Council either ask Eritrea to publish its revenues from gold mining or demand that private gold companies publish all payments to Asmara or pay into a monitored escrow account.