Nadeem Hashmi was released after the investigation team found no evidence against him in the alleged target killing of two policemen in Nazimabad. Hashmi had been booked and arrested under terrorism and murder charges.
"Investigations have proved what we have been saying all along that Hashmi was arrested without any proof," senior MQM member Wasay Jalil said after the lawmaker's release.
Hashmi's arrest last week had led to a shutdown in the city and relations between the MQM and the provincial government of the Peoples Party soured.
MQM had staged a walkout from a Sindh Assembly session in protest of the arrest of Hashmi and other party leaders.
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Meanwhile MQM chief Altaf Hussain told party workers in an address that the central government should not bow down in front of the Taliban militants in order to make the peace talks a reality.
The MQM chief said that if the government caves in to the demands of the militants, conditions in the country would become "worse than those in Somalia".
"Go ahead with peace talks but maintain your dignity," he said, adding the state's writ needed to be protected.