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YANGON (Reuters) - In a remote prison in Myanmar's northernmost state, comedian and dissident Maung Thura nearly lost touch with the world. His parents died. He was forbidden contact with relatives for more than a year.
So when guards startled him awake at 5:30 a.m. on a cool Wednesday morning to free him and about 200 other political prisoners in a rare amnesty, he was ecstatic. He could see his two children again. One of the world's most reclusive and autocratic states may finally be changing, he thought.
But his excitement soon gave way to anger, he said. Nearly 2,000 fellow activists remained in jail in the former British colony also known as Burma, including 18 in his prison in the city of Myitkyina.
"If they really want national reconciliation, they should release all political prisoners," said Maung Thura, better known by his stage name Zarganar, in an interview in Yangon after reuniting with his family about 1,480 km (920 miles) south of the prison.
Is Myanmar really opening up, he asked, echoing a question asked widely of an authoritarian at the strategic crossroads of Asia, which shows signs of ending a half-century of isolation.
The answer, according to diplomats and lawmakers close to Myanmar's leadership, appears to be yes. Reforms that gathered speed this year are likely to continue and possibly accelerate, even if this week's release of prisoners was disappointingly small.
Recent overtures by the government have included calls for peace with ethnic minority groups, some tolerance of criticism, an easing of media controls and more communication with Nobel Peace Prize laureate Aung San Suu Kyi, who was released last year from 15 years of house arrest.
"We talk to them privately and encourage them to continue with reforms but we also suggest they do so at a realistic pace," said a foreign minister of a Southeast Asian nation who communicates with Myanmar's leaders regularly under the ASEAN regional forum.
"If they go too fast and change too much at once, there is a risk that it could backfire, and all the changes that they have made would be unwound," said the minister who declined to be identified by name or nation due to the sensitivity of diplomatic communications with Myanmar.
He and other Southeast Asian diplomats expect the 10-member Association of South East Asian Nations to approve at their summit next month in Bali Myanmar's bid to take its rotating presidency in 2014, two years ahead of schedule, giving the new government some long-sought international recognition.
Reasons behind the wave of reforms are varied.
A local currency crisis is forcing the government to seek urgent help from multilateral institutions. Populist anger is rising over neighbor and historic rival China's expanding economic influence. And Western sanctions are no longer merely a nuisance. They have begun to bite.
The government, say those familiar with its thinking, has begun to covet U.S. and European investments as a counterweight to billions of dollars of Chinese money flowing into its energy industry -- from natural gas to hydro-power and pipeline projects that cater almost exclusively to energy-thirsty China.
Sanctions, they add, also keep some of the Burmese elite's children out of American schools -- a frustration that has grown more acute among a new generation.
And, crucially, since the army nominally handed over of power to a civilian parliament in the first elections in two decades, President Thein Sein has defied skeptics by reaching out to pro-democracy leader Suu Kyi, daughter of assassinated independence hero General Aung San.
Thein Sein, a retired general and first civilian head of state in half a century, surprised Suu Kyi's supporters by appointing one of her friends, U Myint, as chief economic adviser, a step that more than any other could yield reforms in months ahead, say economists who track the country.
U Myint is a dramatic break from decades of staid autocrats and policy blunders by military juntas since a 1962 coup.
The former senior U.N. economist has been openly critical of the former junta, and is a colorful personality, singing and strumming guitar at a World AIDS Day performance in December at Suu Kyi's party headquarters.
The 73-year-old reformer is well regarded on both sides of the political divide, a bridge between pro-democracy forces and conservative former generals who dominate parliament. Recently he called for a crackdown on graft, a bold step in a country ranked second on Transparency International's 2010 list of most corrupt nations, worse than Afghanistan.
His views on Myanmar's currency, the kyat, offer a glimpse into a nation desperate for help. They alone form perhaps the strongest argument for why more reforms are likely.
While the currency is pegged at six kyat to a dollar, it changes hands unofficially at about 850, up about 15 percent this year on sales of natural gas, jade and gems, a surge of foreign investment from China and swelling private capital from neighboring countries and the Middle East.
U Myint sees trouble ahead if the largely Chinese-investment fueled black-market rate keeps rising. In a paper presented to the government in June, he warned it could destabilize Myanmar and urged the government to reach out to the International Monetary Fund for help.
"If the exchange rate continues to appreciate unchecked, a stage will be reached when earnings from exports in local currency are no longer able to cover costs of production, huge losses are incurred, and enterprises have to close down," he wrote, according to a translation of his paper seen by Reuters.
Workers could lose jobs, farmers and fishermen will struggle to sell produce, he said. "The economic, social and political consequences of this chain of events can be serious," he added.
Bread-and-butter issues have been known to turn violent in Myanmar. The biggest and bloodiest uprisings against military rule, in 1988 and 2007, were sparked by discontent over soaring inflation and fuel prices.
The IMF and World Bank cut ties to Myanmar years ago in response to rights abuses. An IMF team will visit this month to study how to unify the official and unofficial exchange rates. But more reforms -- economic and social -- are likely to be the price of their full support.
"The key event will be the re-engagement of the World Bank and the multilateral organizations," said Douglas Clayton, a former hedge fund manager who is now chief executive and managing partner of Leopard Capital, a private-equity fund focused on emerging Asian markets and backed by overseas investors.
"At some point it will be very hard for the West to justify continuing economic sanctions against a country that is undergoing reform," said Clayton.
He sees opportunities "in almost every sector" if sanctions come down -- from manufacturing to infrastructure and agriculture in a country that just over 50 years ago was one of Asia's rising stars, the world's top rice exporter and a major energy producer with a well-educated workforce.
Government sources say U Myint is set to roll out more financial reforms, including allowing some private and semi-government banks to handle foreign currencies, reviewing foreign investment laws and clearing the way for three state-owned banks to open overseas branches.
The pricier currency also points to deeper changes
Mynamar's wealthy converted dollars into kyat last year during a wave of privatization as the junta strengthened control over major assets before ceding power to the civilian government. About 300 state assets -- from real estate, gas stations and toll roads to ports, shipping companies and an airline -- were privatized in opaque sales.
That put valuable assets under the control of former generals through holding companies, or in the hands of their allies, turning the ex-military elite into financial power-brokers who stand to benefit from increased trade if sanctions are brought down - another reason why reforms are under way.
"These moves are about the regime's survival," said Bertil Lintner Thailand-based author and expert on Myanmar.
The timing is crucial. The country, as big as France and Britain combined, sits strategically between booming India and China with ports on the Indian Ocean and Andaman Sea, all of which have made it a vital energy security asset for Beijing's landlocked western provinces.
China now ships 80 percent of its imported oil through the Malacca Strait, a congested sea lane shared by Singapore and Malaysia just a few nautical km (miles) wide in places. Since the September 11, 2001, attacks in the United States, security analysts have long feared a trade-crippling attack there.
Land access to the Indian Ocean through Myanmar would allow Beijing to diversify oil-shipment sources with a quicker route to its western provinces.
Backed by Chinese money, Myanmar is building a new, multi-billion-dollar port through which oil can reach a 790-km (490-mile) pipeline now under construction - with Chinese investments and Chinese workers - that will be cut across Myanmar and link refineries in western China. Another parallel pipeline will pump Myanmar's offshore natural gas to China.
That, along with hydro-power dams and highway projects, underpins more than $14 billion of pledged Chinese investment in Myanmar's 2010/11 (April-March) fiscal year, causing total foreign direct investment promises to soar to $20 billion from just $300 million a year before, official data showed.
Much of that money ends up in the pockets of a small circle of business elite and former generals, including some hardliners of the former junta. About a third of Myanmar's 50 million people, live in poverty, according to U.N. data.
"Over the last two years, anti-Chinese sentiment has really been swelling," said Sean Turnell, an economist who studies Myanmar at Australia's Macquarie University. "Even Burmese business people are seeing that Chinese domination is probably not good for the country. It is all short-term cash in exchange for what is often incredible environmental damage."
The strongest indicator of reform, said Turnell, happened on September 30 when the president suspended the $3.6 billion, Chinese-led Myitsone dam project, Myanmar's largest hydropower project, saying he had to act "according to the desire of the people."
Its construction was shelved during his five-year term.
The dam was backed by hard-liners with ties to China and opposed by an increasingly vocal band of reformers. Some politicians appeared to fear they may not be re-elected if they defied public opinion and threw their support behind it, a sign democracy may be taking root after last year's elections.
The dam would have flooded an area about the size of Singapore, creating a 766-square-km (296-square-mile) reservoir, mainly to serve growing energy needs in northern neighbor China, which would have imported about 90 percent of its power.
It became a symbol of resentment over China and marked the first real public test over whether reformers or hard-liners had more sway over the country's direction. Myanmar's ethnic Kachin, bordering China, opposed the dam since 2007. Emotions over the project spilled into violent skirmishes between Myanmar's military and the Kachin Independence Army.
Its Burmese developer, Asia World Co, is controlled by Steven Law and his father, Lo Hsing Han, who the U.S. Treasury describes as "financial operatives" of the former military junta. The project is also backed by Zaw Min, a powerful lawmaker and close ally to former strongman Than Shwe, who stepped down as head of state this year.
"Up until the dam, there really hadn't been any reform that would confront vested interests," said Turnell. "The decision to suspend it upset the Chinese. But it also upset some cronies who were connected to the regime who were partners with Chinese investors.
"I think this new president is genuinely reflecting a public mood and a public disquiet, and that is why his decision on the dam was significant. There is a bit of an internal conflict within Burma between various groups. It seems to be that the new president has decided that the best way to shore up his position is by cultivating the reform narrative," he said.
Recognizing this, India and Southeast Asia have sought to ramp up engagement, largely to counterbalance China's influence and to gain a toehold in a country whose proven gas reserves have tripled in the past decade to around 800 billion cubic meters, equivalent to more than a quarter of Australia's, BP Statistical Review figures show.
But even if the reforms continue, Myanmar faces a daunting public relations exercise to end its image as a backwater run by autocratic former generals and drug lords, blighted by conflicts and years of brutal suppression of pro-democracy uprisings.
"I would also suggest that even if the current regime in Burma/Myanmar were to convince the U.S. government to ease the sanctions regime, the investment climate might still be problematic for publicly traded Western companies because of the regime's brutal record of political repression," said Kevin Whited, a senior political risk analyst at consultants HIS.
Jason Szep reported from Bangkok; Additional reporting by Martin Petty in Bangkok and Anna Driver in Houston; editing by Bill Tarrant