ISLAMABAD (Reuters) - Pakistan's powerful spy agency appears to have gained the most from a CIA contractor's release, by forcing the U.S. agency to recognize its importance to the U.S. effort in Afghanistan, and curtailing American activities in Pakistan.

A Pakistani court on Wednesday acquitted CIA contractor Raymond Davis, 36, of murder charges and released him after a deal that involved paying compensation - "blood money" - to the victims' families. Davis shot and killed two men he said were trying to rob him in Pakistani city Lahore on January 27.

The revelation of armed CIA contractors working in Pakistan deeply angered and embarrassed the Directorate of Inter-Services Intelligence (ISI), Pakistan's spy agency.

"Very clearly, the ISI was upset because it's a parallel network of intelligence the U.S. appears to have set up," said Ayesha Siddiqa, a military analyst. The ISI wants the United States to rein in contractors like Davis and clear any monitoring of militant groups with it first.

"They want to keep a close eye on the American operations," she said. "There might be an agreement, 'If you want information on these guys, we'll provide it.'"

Pakistan is considered vital to the American-led effort to stabilize Afghanistan and prevent it from again becoming an al Qaeda sanctuary. The cooperation of the Pakistani military and ISI is critical in tackling militant hideouts on the Pakistani side of the border.

Any rapprochement between the CIA and the ISI has at its heart one idea, Siddiqa said: "Whatever you do in Afghanistan, we have to be at the center of it, we have to be involved."

A U.S. official, who requested anonymity because of the sensitivity of the issue, said that relations with Pakistan had taken a hit, especially regarding cooperation in Afghanistan and addressing the country's dire economic condition, but Washington hoped to get the relationship back on track.

"What was the price we paid?" the official said. "We could have made a lot more progress in that time if we hadn't been concentrating on Davis."


"Blood money" - called diyat - is a common and accepted practice in Islamic law and Pakistan's criminal code. The United States for weeks argued that Davis had diplomatic immunity, but eventually settled on diyat as a solution to get him released.

According to the diyat agreement, a copy of which was obtained by Reuters, the families of Faizan Haider and Faheem Shamshad were each paid 100 million rupees ($1.17 million) to be distributed among the family members.

The expected fury at Davis' release has yet to fully materialize, indicating the public largely accepts the payment.

"I don't see any reason for protesting on this issue," said Muhammad Ahsan, a final year student at an Islamic school in Karachi. "If we have to protest, we need to protest against the overall policies of the government and their unequal relationship with the U.S., but we can't protest against the family for taking blood money. It is their right."

Pakistan's military and intelligence agencies are also likely to be calming the religious parties, with which they have close ties and which have been loudest in calling for Davis' head, Siddiqa said.

In the hours following the news of Davis' release on Wednesday night, only fitful demonstrations flared up around the country. Some 50 protesters tried to enter the U.S. consulate in Lahore, but were beaten back by police. Outside the Press Club in Karachi, between 100 and 150 members of a hardline Islamic political party staged a protest. In Islamabad, 12 people chanted slogans outside the Press Club.

On Thursday, small protests of students and religious parties occurred in Karachi, Multan, Peshawar, Lahore and Islamabad, but no more than 200 or 300 people attended any single protest, witnesses said.

"I think the issue will just die down in a week or two," said Mahmood ul Hassan, a general store owner in a middle class Karachi neighborhood. "We are not Egypt, we don't have the guts to come out on the streets and throw out the government."

(Additional reporting by Faisal Aziz in Karachi, Zeeshan Haider and Mian Khursheed in Islamabad, and Mubasher Bokhari in Lahore; Editing by Daniel Magnowski)