Jakarta – A proposal by Indonesia to limit foreign investors' participation in certain share issues could scare off overseas investment, some analysts and fund managers said.

Hatta Rajasa, co-ordinating economic minister, on Friday told reporters that the government is discussing with Bapepam, the capital markets regulator, whether to allow foreign investors to participate in rights issues by companies which have already reached their foreign ownership limits.

Rajasa said in cases where foreigners already owned the maximum 49 percent of a listed Indonesian firm, that company may be prevented from selling shares in a rights issue to foreigners to avoid exceeding the limit.

The rule applies to sectors where foreign ownership is restricted. The list is currently being amended and under discussion by various ministries.

One analyst who declined to be quoted by name said Rajasa's comments may be aimed at closing a loophole in existing rules. "People can get around the limits by listing the company and using rights issues. So this could clarify the issue and close the loophole," the analyst said.

In cases where a company was unable to raise the funds from local investors, it might be allowed to sell the rights to foreigners but only on condition that the foreign ownership was restored to 49 percent within two years, Rajasa said.

"We haven't decided yet, only some ideas, and we still have to discuss it with Bapepam," he added.

The comments by Rajasa, regarded as one of the more protectionist members of President Susilo Bambang Yudhoyono's cabinet, could potentially dampen investor sentiment, some analysts and investors said.

Investor James Bryson of fund management firm HB Capital said that given the lack of detail in Rajasa's comments, it was difficult to predict which sectors or companies might be affected, "but wherever it is, it is not good news."

"Those wanting to raise money via minorities taking up their rights, might well find that the rights issues would not achieve their aim, if otherwise-willing foreign minorities weren't allowed to do so."

Indonesian stocks surged nearly 90 percent last year in a rally fuelled by optimism over strong economic growth and political stability.

[Reporting by Sonya Angraini and Sara Webb; Editing by Tomasz Janowski.]