* Heavy hand of state seen stifling innovation
* Telecoms, Internet in hands of state monopoly
* Government says state role ensures broad development
By Aaron Maasho
ADDIS ABABA, Nov 17 (Reuters) - In Ethiopia, where state spending rather than private enterprise has been the driving force behind double-digit economic growth, tech entrepreneurs like Araya Lakew feel stuck in the slow lane.
Five years ago, the 34-year-old spotted a niche for a website matching buyers and sellers of second-hand cars in a nation where prices often rise even as vehicles age because of high tariffs on imports.
His website, Mekina.net, receives 316,000 hits a month and adds 20 cars a day to its sales list but he has struggled to expand beyond the capital because of poor Internet penetration and a ropey mobile network run by state monopoly Ethio Telecom.
"We are only touching a tiny surface of the market," Araya told Reuters. "We try to optimise what we have as there are a lot of obstacles to growth."
In a nation where the authorities have little tolerance of criticism, Ethiopian entrepreneurs are reluctant to blame the government or its agencies for the challenges they face.
But economists say the state's tight grip and a list of restrictions on where private business and foreigners can invest risk stifling tech and other start-ups that will be vital for creating jobs and driving innovation.
"The way things stand, this sector may not survive," said Markos Lemma, co-founder of iceaddis, a technology hub in Addis Ababa that supports entrepreneurs. "Ethiopia is leaving out a huge talent-based opportunity."
Telecoms services are in the hands of the state, while foreigners are barred from retail and banking. Entrepreneurs struggle for funds as banks have to invest the equivalent of 27 percent of their loan portfolio in low-yielding state development bonds, leaving less for private lending.
Araya said private equity firms had shown interest in his plans. "But they are put off by the regulations," he said.
Ethiopians only need look south to Kenya to see what a more free-wheeling approach could deliver in a nation where telecoms firms and Internet providers are in private hands.
Two thirds of Kenya's 45 million people had Internet access as of March 2015, while in Ethiopia, a nation of more than 95 million, it was just 2.9 percent at the end of 2014, figures compiled by private firm Internet World Stats showed.
In terms of innovation, Kenya's biggest operator, Safaricom , partly owned by Britain's Vodafone, pioneered a system in 2007 that allows Kenyans to pay bills or receive funds on the simplest of mobile phones.
M-Pesa swept across Kenya, where few people have formal bank accounts, and has been mimicked across Africa.
But in Ethiopia, similar 'mobile money' systems are less than two years old and cash is still king.
"That is a major issue for us," said Feleg Tsegaye, founder of Deliver Addis, Ethiopia's first online food delivery service, adding that mobile payments would make his service more efficient. "We are currently not at that level yet."
Mobile users complain that even basic telephone coverage is poor and Internet speeds are sluggish even in the capital, although Ethio Telecom is rolling out faster services.
But the government shows no sign of easing its grip, citing economic growth that is on track to exceed 10 percent this year, one of the fastest in Africa.
It says profits from Ethio Telecom are ploughed back into a range of infrastructure projects, such as railways. The firm generated revenues of 21.5 billion birr ($1.03 billion) in fiscal 2014/15 and gross profit of 14.5 billion birr.
"Profit is not a measure or a yardstick for our decision but rather its developmental impact," Deputy Prime Minister Debretsion Gebremichael, who is also Minister of Communications and Information Technology, told Reuters.
On a continent with poor transport and clogged city streets, Addis Ababa opened Sub-Saharan Africa's first urban metro system this year and is building an extensive national rail network.
The government says no private firm would show the same interest as the state does in providing mobile coverage across sparsely populated regions of a nation where annual income per capita is just $550, well below the Sub-Saharan average, according to World Bank figures.
Economists acknowledge Ethiopia has done more than most in ensuring remote areas benefit from growth and in turning around the fortunes of what was almost a failed state three decades ago after years of "Red Terror" communist purges and famine.
But they say greater openness to private business could offer efficiencies and, in the case of telecoms, generate more revenues in taxes and stimulate innovation.
"International experience would suggest that if you were to open, you would get lower prices, higher quality and better coverage," said Lars Christian Moller, the World Bank's outgoing chief economist on Ethiopia. "Then there is the dynamism of start-ups - that kind of dynamism you might miss out on."
$1 = 20.8425 birr Editing by Edmund Blair and Giles Elgood