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A worker makes a regular check on machines in a textile factory in Diyarbakir March 21, 2017. REUTERS/Umit Bektas

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By Daren Butler and Humeyra Pamuk

DIYARBAKIR, Turkey (Reuters) - In Turkey's mainly Kurdish southeast, deeply scarred by conflict between state forces and militants, a textile firm that supplies companies across Europe plans three new factories - a rare bet the government can deliver on a vow to regenerate the region.

The government announced a $2.8 billion investment scheme for the area in September, hoping to win over the population with the prospect of economic revival before a referendum later this month on expanding President Tayyip Erdogan's powers.

The Iskur group, a supplier to fashion brands including Zara, Adidas and Nike, sees its $100 million investment as showing the way for other companies from western Turkey to take advantage of government incentives and lower wages in the east.

Undaunted by the militant Kurdistan Workers Party's (PKK) decades-old insurgency, it has been operating a $30 million cotton thread plant outside the region's biggest city Diyarbakir since 2014 but few others have followed its lead.

"We have opened a door in Diyarbakir, creating an example for other investors in the west," plant manager Ekrem Kul told Reuters as workers tended to rows of machines spinning thread.

Iskur halted expansion plans in 2015 with the outbreak of some of the worst fighting since the PKK took up arms in 1984, but Kul said it revived them after the government initiative. It aims to employ more than 2,000 people in the new Diyarbakir plants, up from just 330 now.

Its optimism is rare in a region where, according to the United Nations, the upsurge in violence between July 2015 and December 2016 killed around 2,000 people, devastated whole neighbourhoods and drove half a million people from their homes.

The ruling AK Party, founded by Erdogan, owed much of its early success to its stewardship of the economy after coming to power in 2002, improving roads, building bridges and hospitals.

The pro-Kurdish HDP says the government has, however, failed to solve the problems of the southeast, where more than 40,000 people have been killed in three decades of conflict.

The government counters it has boosted per capita income in the area to $5,000 from $800 with extensive state investment.

Prime Minister Binali Yildirim promised new factories, housing, hospitals and sports stadiums under the investment plan. Urbanisation Minister Mehmet Ozhaseki told reporters on Saturday state investments have so far focused on reconstruction of buildings damaged in the conflict.

Alican Ebedinoglu, president of one Diyarbakir trade association, is sceptical private investment will follow.

"Every new government has made fresh legislation to provide incentives for investment in the region. But without peace and calm, these incentive packages don't mean much. If there is peace, the region hardly needs any incentives," Ebedinoglu said.

"BUSINESS EVAPORATED"

Erdogan won support among Kurds for spearheading a peace process in 2013, the first time Kurdish political demands had been addressed, and for easing some restrictions on them.

But after a ceasefire with the militants collapsed in July 2015 he has ruled out a return to negotiations, saying security forces will "annihilate" the PKK, which is considered a terrorist organisation by Turkey, the United States and Europe.

In events echoed in other towns in the southeast, armed youths dug trenches and laid explosives in Diyarbakir's ancient Sur district that is encircled by towering, Roman-era walls. Security forces fought back with tanks.

Security operations ended in Sur a year ago, but there are checkpoints all across the city and concrete blocks placed in front of buildings deemed vulnerable to the sporadic bombing attacks on security forces that have taken place since.

Ebedinoglu said the fighting caused 500 businesses to shut down completely, while shopkeepers were forced to close their stores for weeks or months at a time when the violence surged, meaning they fell behind on rent and debt payments.

"The government has said it will provide interest-free loans but that's a myth. You wouldn't be able to find 100 people around here that the banks would lend to unless their credit background is entirely erased."

Mustafa Avcilar, owner of a cafe in a 16th century courtyard once popular with tourists, closed it for months as clashes raged nearby.

"Once the fighting began, business evaporated in the blink of an eye. A wave of tension swept over the city," said the 52-year-old, speaking as trade was picking up in the Sur district.

The industrial zone where the Iskur thread factory is based is 20 km (12 miles) north of the city, far from the focus of the fighting, but it was not immune. "It affected our workers' ability to come to work easily - their psychological states, their productivity. We experienced difficult days," Kul said.

Household disposable incomes are around half the national average of $4,500 in the southeast and official unemployment in some provinces is 28 percent, more than twice the national average, a figure some local business say is an underestimate.

In the four provinces, including Diyarbakir, most affected by the recent conflict, the pro-Kurdish HDP won around three quarters of the vote at the last parliamentary elections in November 2015. However, the AK Party attracts greater support in less troubled provinces of the southeast.

Diyarbakir, a city of more than 1.5 million, is better off than rural areas. Apartment blocks have mushroomed and modern shopping malls add to the appearance of growing prosperity, but Ahmet Sayar, head of the Diyarbakir Chamber of Commerce said there is a long way to go.

"For there to be a leap forward in achieving the economic potential as a region there needs to be an environment of predictability, stability, peace and confidence.," he said.

For workers too, a return of the ceasefire is vital.

"We did not have these troubles during the peace process, we could come to work easily," said Ramazan Yildiz, an employee at the Iskur plant.

"We go home in fear in the evenings, we come to work in fear, thinking, 'Will there be any problem or clashes on the road?'."

($1 = 3.6384 liras)

(Editing by David Dolan and Philippa Fletcher)

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