JAKARTA, Oct 17 - Indonesia is hoping to attract up to $ 5 billion in new foreign investm

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JAKARTA, Oct 17 (Reuters) - Indonesia is hoping to attract up to $5 billion in new foreign investment to Riau Islands over the next five years after parliament passed a bill last week turning the area into a free trade zone, its governor said on Wednesday.

The free trade bill offers investors benefits including exemption from import duties, value added tax and sales tax on luxury goods in the main industrial islands of the province, which lies just across from Singapore.

Riau Islands -- which include the three industrial islands of Batam, Bintan, and Karimun -- is one of Indonesia's richest provinces, which already has many foreign firms in sectors like electronics and shipping because of its investor-friendly taxation rules.

So far, foreign investors have pumped in around $9 billion in the area, much of it in Batam island which has long been groomed as an industrial zone with special facilities for industries.

''Parliament's approval is a positive sign for foreign investors from all over the world. We have 26 signed agreements worth $1.7 billion spread over Batam, Bintan, and Karimun waiting for the law,'' Ismeth Abdullah told Reuters in an interview.

''Among the big players seriously interested in investing are an oil company from the U.S. and an Italian shipyard firm.

The two of them combined will contribute around $600 million.'' Abdullah said major companies from Singapore, Japan, Taiwan, Europe and the Middle East were also interested in investing in the islands after the law, which could create about 900,000 jobs over the next five years.

''We will control all the investment activities at an integrated office, to avoid bureaucratic hurdles in FTZ. We will make those three islands as a zero obstacle zone for investment,'' he said.

The new bill, which still has to be approved by the president to turn into law, only applies to the three islands, but Abdullah said he expects the benefits to trickle down to the entire province.

Indonesia, Southeast Asia's largest economy, has been struggling to attract foreign investment and reduce the unemployment rate as it emerges from the wreckage of the 1997/98 Asian financial crisis.

Foreign investment has been falling and some investors say graft, red tape, an unfriendly bureaucracy, tough labour laws and an unreliable legal system make Indonesia a poor choice compared with some regional rivals.

Last year, actual foreign direct investment (FDI) plunged to $5.98 billion from $8.91 billion in 2005, although FDI approvals were up to $15.62 billion from $13.58 billion.

Abdullah said foreign investors from a range of sectors such as pharmaceuticals, chemicals, oil and gas and automotive spare parts were interested in investing in Riau province.

Fresh investment will almost double the share of exports from the islands to 25 percent of Indonesia's total exports over the next five years, from 14 percent currently.

Indonesia's exports reached $100.69 billion last year, and were up 14.3 percent in the first half of 2007 to $53.62 billion. Abdullah said.

(Additional reporting by Yayat Supriatna) REUTERS SI DS1642

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