By Maria Golovnina and Syed Raza Hassan
ISLAMABAD (Reuters) - A Pakistani Islamist with a $10 million U.S. bounty on his head appeared openly at a rally in Islamabad on Friday, denouncing India as a terrorist state as thousands of his supporters chanted for "holy war" against the rival nuclear nation.
India has accused Hafiz Saeed of masterminding the 2008 attack on its financial capital Mumbai where gunmen killed 166 people over three days. The United States has offered $10 million for information leading to his arrest and conviction.
As dusk fell, more than 10,000 people gathered in Islamabad in a show of defiance certain to enrage India further following weeks of tensions over the disputed Kashmir border.
"The United States and India are very angry with us. This means God is happy with us," Saeed told the crowd as supporters chanted "Jihad!" ("Holy war") and "War will continue until the liberation of Kashmir". He did not use the word "jihad" himself.
"We are ready for every sacrifice for the liberation of Kashmir," the stocky and bearded former professor added at the rally marking Pakistan's Defense Day.
Speaking about Sarabjit Singh, an Indian prisoner who died in a Pakistani jail this year and was given a state funeral back home, Saeed told the crowd: "He was a terrorist. How can the Indian government give state honors to a terrorist? This means the Indian government and army are terrorists."
India has called on Pakistan to bring Saeed to justice, an issue that has stood in the way of rebuilding relations between the nuclear-armed neighbors since the Mumbai carnage.
Saeed is the founder of Lashkar-e-Taiba (LeT), a militant group banned in Pakistan but tolerated unofficially and believed to be close to the army. Saeed has long abandoned its leadership and is now the head of its charity wing.
India is furious that Pakistan has not detained him since it handed over evidence against him to Islamabad, and allows Saeed to live freely in the city of Lahore in a villa with police stationed outside.
Relations plunged to further lows last month after the killing of five Indian soldiers along the so-called Line of Control that separates the two sides in the Himalayan region of Kashmir.
Seeking to defuse tensions, Pakistan's civilian leaders have kept a conciliatory tone, but on Friday, as thousands gathered in Islamabad, emotions spilled into the open.
The mood was strikingly anti-Western and belligerent, with speakers openly declaring their sympathy for the Taliban fighting Western forces in neighboring Afghanistan.
"India should stop describing Kashmir as its indispensable part," Saeed said from a makeshift stage mounted on a truck. "Otherwise every part of India would be dispensable for us."
As the crowd cheered, two men performed a patriotic song threatening to "turn the whole of India into Mumbai". Others chanted "Whoever is a friend of India is a traitor" and waved black and white striped flags.
"They should know there are a lot of people here who are waiting for the conquest of India," Hamid Gul, a former chief of the ISI intelligence service, told the crowd.
"It will be our privilege to take part in this war."
Saeed founded the LeT, which India blames for the rampage in Mumbai, in the 1990s. He has denied involvement in any attacks.
He abandoned the leadership after India accused the LeT of being behind an attack on the Indian parliament in December 2001. His charity, linked to the LeT, enjoys popular support for its humanitarian work.
(Additional reporting by Amjad Ali; Writing by Maria Golovnina; Editing by Mark Trevelyan)