Thai troops encircled thousands of protesters encamped near the prime minister's office in Bangkok early on Tuesday after a day of street clashes in which two people were killed and dozens injured.
Prime Minister Abhisit Vejjajiva, who declared a state of emergency in Bangkok on Sunday, urged the protesters to leave. He told Reuters his aim was to restore law and order but said their rights would be respected.
In an interview with Reuters, Abhisit ruled out an immediate dissolution of parliament and said he was not interested in making a deal with exiled former Prime Minister Thaksin Shinawatra, the figurehead of the protest movement.
Speaking of the "Red Shirt" protesters, he said: "If they are not inciting violence, if they are not engaged in riots, if they don't have weapons, then they can exercise their rights."
With Humvees and armored personnel carriers, the army and police set up a perimeter around an estimated 6,000 demonstrators, including women, children and a few Buddhist monks, who were calling for the resignation of Abhisit.
But some of demonstrators prepared for a confrontation, felling trees and laying them across a main road between the troops and the center of the protest, stockpiling rocks and bricks and dousing disabled buses in the street with petrol.
The protest stems from an intractable dispute pitting royalists, the military and the urban middle-class against a poorer rural majority loyal to the exiled former prime minister.
Abhisit said in the interview that dissolving parliament could lead to electoral violence. But he said he was willing to listen to the grievances of some of the protesters.
On Monday black smoke billowed over the city of 12 million people after protesters set fire to several buses to block the troops. The side of one government building was ablaze.
Soldiers drove them back with repeated charges and fusillades of assault rifle fire, aimed at the sky and the crowd.
One person was shot dead in fighting between protesters and residents angry about the demonstrations, Satit Wongnongtaey, a minister at the prime minister's office, said on television.
A hospital said another person was also fatally shot in the violence under similar circumstance, and there was sporadic fighting between protesters and locals in the evening.
The Emergency Medical Institute said on Monday night 94 people, including soldiers, were injured in the clashes.
Thaksin, ousted in 2006 coup and living in exile, told CNN from an undisclosed location: "Many people are dying... They even take the bodies on the military trucks and take them away."
The demonstrations have further hobbled a country reeling from political chaos last year and the global financial crisis.
Rating agencies Standard & Poor's and Moody's, both of which already have a negative outlook on Thailand's sovereign ratings, said the renewed political unrest increased the risk of a downgrade.
"Tourism can rebound, but investor confidence will be very hard to get back," said S&P analyst Kim Eng Tan. "Going forward we expect investors will become a lot more risk averse."
Thailand's top military commander, General Songkitti Chakabakr, said in a televised statement on Monday that the committee charged with restoring order would strive "through every peaceful means" to bring the situation back to normal as soon as possible.
On Saturday protesters forced the cancellation of a high-profile Asian summit in Thailand, a big embarrassment for Abhisit, who took office only in December.
"I believe the darkest days in Thailand's history are yet to come as we see no swift solution to ongoing divisiveness," said Prinn Panitchpakdi, a CLSA Asia-Pacific analyst.
Several countries issued cautionary advisories on travel to Thailand.
The violence on Monday began before dawn, at the start of the Thai New Year holiday, much of it near one of the city's central traffic hubs, Din Daeng junction, which protesters had blockaded.
Last year politicians backed by the "Red Shirts" were in power and royalist "Yellow Shirts," supporters of those now in government, held nearly non-stop protests, culminating in a week-long occupation of Bangkok's main airport.
The political strife died down for a while after Abhisit came to office through parliamentary defections that Thaksin supporters say the army engineered. They demand a new election.
Protests flared anew after Thaksin, living in exile to avoid jail on a corruption conviction, said Abhisit must resign by April 8 -- the day before Thailand was to host the now abandoned East Asia Summit in the beach resort of Pattaya.
Thailand has had 18 coups since 1932 and the military often has the final say in Thai politics, sometimes with the blessing of the king.