Inside Parliament: Thatcher entourage 'entangled' in dam fiasco: Sir David Steel accuses Tory backers of links to trade deals - Government retreats on the Police and Magistrates' Courts Bill

Baroness Thatcher's entourage, including a close friend of her son, Mark Thatcher, were closely involved in setting up the Pergau dam deal, Sir David Steel said yesterday. He told MPs that the unfolding fiascos over the dam and arms to Iraq had revealed a government sloppy in its use of power and cavalier in its treatment of the Commons.

Opening an ill-tempered debate on Britain's overseas aid programme, Sir David, foreign affairs spokesman for the Liberal Democrats, said ministers had sought to mislead MPs by concealing the truth.

He was accused by Tory backbenchers of being 'naive' and threatening jobs by further upsetting Malaysia, which has banned new contracts with British firms. The Foreign Office minister Alastair Goodlad said Sir David's suggestion of a connection between companies that worked on projects funded by the Aid and Trade Provision (ATP) and contributions to the Conservative Party was 'a classic case of the smear and innuendo that Malaysians have found so offensive'. It was unfair to officials of the Overseas Development Administration that vetted projects and to the foreign governments concerned.

Julian Brazier, MP for Canterbury, protested: 'A nonsensical campaign whipped up by opposition members has done incalculable damage to our trading relations with a very important trading partner.'

Winding up the debate, Richard Needham, Minister of State for Trade and Industry, singled out the Independent and the Sunday Times for particular criticism.

Sir David said it was the Government that had created the mess by its misuse of aid money. The House would be failing in its most fundamental duty if it did not censure the Government for spending pounds 284m on the Pergau project after it had been condemned by Sir Tim Lankester, then permanent secretary at the ODA, as bad in economic terms and an 'abuse of the aid programme'.

Ministers had been so keen to re- establish trade with Malaysia that they set aside a whole series of normal procedures. He recalled the words of Sir George Younger, former Secretary of State for Defence, that a 'verbal understanding was given by somebody to link the aid to the defence contract'.

'The House is entitled to know who was that somebody,' Sir David declared. He said that in the course of batting for Britain, Margaret Thatcher's close circle often seemed to have been involved.

'In this case, Sir Tim Bell, well known as her public relations advisor, is also advisor to the Malaysian prime minister and to Tan Sri Armugam, who controls GEC Malaysia, heavily involved in several of the contracts under the deal. One other person who helped to broker parts of the deal is Steve Tipping, a business associate of Mark Thatcher and indeed best man at his wedding.'

Sir David said companies linked by donations to the Conservative Party had benefited to the tune of 42 per cent of the ATP. They included Cementation International, owned by Trafalgar House, Balfour Beatty, GEC, Amec International, Biwater, Davy and British Airways.

'I am not alleging that there is anything so corrupt as a direct link between the donations to the party in government and their receipt of ATP from the Government. Perish the thought. It is just that the two have in a somewhat unseemly manner 'become entangled'.'

Sir David recommended the outlawing of corporate donations to political parties, US-style legislation against arms sales to regimes with appalling human rights records, no 'sweeteners or payments to middle men', an increase in overseas aid and the transfer of ATP assistance to the budget of the trade and industry department. His party's motion codemning the Government over the Pergau affair was defeated by 305 votes to 159.

Mr Goodlad said if the commitment to the Pergau project had not been carried through, Britain's credibility as a trading and investment partner would have been seriously damaged. It was 'ridiculous' to suggest that where there was a defence sales relationship that a particular government should be ineligible for ATP.

Tom Clarke, Labour's overseas development spokesman, said: 'Vested interests have a deep control of the Tory Party and have very little to do with the needs of the Third World and the poorest.' The Pergau project was 'one of the most shameful episodes among many in the history of this Government'.

Den Dover, Conservative MP for Chorley, said 'stupid media hype' could cost Britain the contract to build Mayalsia's new international airport. His colleague Andrew Hargreaves, MP for Hall Green, claimed 'one or two' newspaper editors were waging vendettas against the Prime Minister and some other ministers.

In a packed House of Lords, the Government was shot down over the latest U-turn on the battle- worn Police and Magistrates' Courts Bill.

Under yesterday's concessions, local council representatives will be allowed a majority of one on new-style police authorities, most of them to have 17 members.

Earl Ferrers, the Home Office minister, also unveiled a complex procedure for choosing co-opted members.

A shortlist of 20 would initially be drawn up by a three-strong selection panel in each of the 43 police areas, to be whittled down to 10 by the Home Secretary. Councillor and JP members of the authorities would then select (normally) five co-opted members.

Lord Jenkins of Hillhead, Liberal Democrat leader in the upper house, labelled the Bill 'humiliation by instalment' and a classic example of how not to legislate.

As Earl Ferrers protested inside the chamber that the retreats from the original provisions were 'exactly what democracy is all about', Tony Blair, the shadow home secretary, declared outside it: 'We will now have independent selection panels that no one wants, choosing short-lists of nominees that no one supports, from which other members of the authority will be forced to choose colleagues whose presence they disagree with - all to save a plan that no one has consented to.'