* West saw old regime as economic success
* Rampant corruption tough to tackle
* Unemployment among educated youth rising
By Lin Noueihed
TUNIS, Feb 1 (Reuters) - Tackling corruption and expanding the private sector will be key to Tunisia's ability to transform its economy and spur the job creation its disaffected youth is demanding, but there are no quick policy solutions.
Fitch ratings agency last week slashed its 2011 economic growth forecast for Tunisia to 2 percent from 5 percent in the wake of the pro-democracy revolt this month and forecast foreign direct investment could fall by a third this year.
Unlike neighbours Algeria and Libya, Tunisia does not sit atop vast oil and gas reserves. It does, however, have a relatively diversified economy and economists say it has the potential to move further up the value chain with the right mix of policies and commitment to long-term investment. Tunisians blame many of their woes, most notably high unemployment -- at 13 percent officially but probably far higher -- on ousted President Zine al-Abidine Ben Ali and his family, accusing them of accumulating wealth at the expense of the people during his 23-year regime.
For all its corruption and nepotism, though, the old regime was doing some things right. Tunisia was feted by its Western allies as an economic success story, averaging 5 percent growth annually over the past decade, according to the IMF.
It also implemented a privatisation programme and slashed public debt to 43 percent of gross domestic product in 2010 from 60 percent in 2001.
Analysts say the government that takes over from the interim administration should continue to cut public debt and encourage foreign investment -- which had grown to 6 percent of GDP in 2008 before being halved during the financial crisis -- policies that have been praised by the International Monetary Fund.
"Staff viewed the fiscal stance in 2010 as striking the right balance between supporting growth and preserving the significant gains achieved in bringing public debt down," the IMF said in its 2010 article IV report on Tunisia.
Only 7 percent of Tunisia's population lives in poverty, the World Bank says, one of the lowest levels in the region and population growth is slower than in other countries in North Africa and the Middle East thanks to family planning support.
But like in Egypt and other parts of the region, rising unemployment has created widespread social tension and was one of the main triggers of the uprising against Ben Ali.
Spurring job creation to help ease the grievances of young people, who comprise about a third of Tunisia's unemployed, will be crucial to the next government's survival.
EDUCATED WORKFORCE
A highly educated workforce -- a third of Tunisians enter tertiary education compared to less than 13 percent of Moroccans -- is creating problems of its own as a large, urbanised middle class aspires to the higher salaries and generous benefits found across the Mediterranean in Europe.
The World Bank says the number of unemployed graduates has doubled over the past 10 years.
"We have bachelors degrees but we have no jobs," said one woman, protesting outside the education ministry last week.
"We don't have the right to work in our country."
Nearly half of graduates with a masters degree are unemployed.
"The economy can only absorb 25,000 jobs a year but it has over 60,000 educated people entering the job market," said Tunisian economist Murad Benturkiye.
The number of graduates should start to fall from 2013 but private sector growth still needs to accelerate, he said.
"We can absorb this number of unemployed if we grow a little more, just one or two percentage points more a year. To do this, more focus should be placed on the private sector. The good thing for the next government is that all the sectors in Tunisia have not reached their full potential."
The financial sector in particular needs to consolidate and boost competitiveness to enable banks to strengthen their weak capital base, develop retail banking and expand into other North African countries, analysts say.
A visitor would also be hard pressed to find a foreign fast food chain on the streets of Tunis. Protectionism in the sector has done little to help Tunisia develop big brands that can compete overseas. Across industries more liberalisation is needed to encourage foreign investors to work with local industry rather than just using Tunisia to produce cheap goods for export only.
Even tourism, a major income source which employs 400,000 people, has room for growth if the government can facilitate investment in more hotels and resorts.
BUREAUCRACY AND CORRUPTION
To succeed with any reforms though, the future government will have make inroads in tackling corruption.
The interim government has already set up an independent committee to investigate bribery and corruption, but it faces an enormous task.
Tunisia has fallen to 59th place in Transparency International's 2010 Corruption Perceptions Index, from 45th just five years ago although it had the highest 2010 ranking in North Africa, ahead of Morocco in 85th place and Egypt in 98th.
While foreign investors have tended not to complain about graft, economists say it has long stunted growth in the private sector and skewed access to jobs in the public sector.
Tunisians say they can only get public sector jobs through connections or bribes, a practice that will be difficult to change in the short term as state salaries remain low and state employees look on the bribes they receive as a kind of bonus.
In the private sector, Tunisians say Ben Ali's family and friends demanded a cut of the profits from any large project, dampening the incentives for Tunisians to set up businesses.
Economist Fathi Jribi says the government needs to appoint an independent auditor to monitor everything from public finances to economic data.
"We should have an independent audit, so the people behind the policies are not the same people who are coming up with the statistics," he said.
"Under a dictatorship, there is no real supply and demand. A dictator does not consult. He makes up the numbers."
Fitch says Tunisia's economy could recover next year provided there is a stable government, but the path to sustainable reform will not be easy.
Full convertibility of the Tunisian dinar would be an important step, potentially unleashing a surge in investment and helping Tunis secure more preferential trading terms with the European Union, but its 2014 deadline now looks set to be delayed in light of the political turmoil. (Editing by Susan Fenton)