Ethiopia's bold decision to pay for a huge dam itself has overturned generations of Egyptian control over the Nile's waters, and may help transform one of the world's poorest countries into a regional hydropower hub.

By spurning an offer from Cairo for help financing the project, Addis Ababa has ensured it controls the construction of the Renaissance Dam on a Nile tributary. The electricity it will generate - enough to power a giant rich-world city like New York - can be exported across a power-hungry region.

But the decision to fund the huge project itself also carries the risk of stifling private sector investment and restricting economic growth, and may jeopardise Ethiopia's dream of becoming a middle income country by 2025.

The dam is now a quarter built and Ethiopia says it will start producing its first 750 megawatts of electricity by the end of this year. In the sandy floor of the Guba valley, near the Sudanese border, engineers are laying compacted concrete to the foundations of the barrage that will tower 145 metres high and whose turbines will throw out 6,000 megawatts - more than any other hydropower project in Africa.

So far, Ethiopia has paid 27 billion birr ($1.5 billion) out of a total projected cost of 77 billion birr for the dam, which will create a lake 246 km (153 miles) long.

It is the biggest part of a massive programme of public spending on power, roads and railways in one of Africa's fastest growing economies. Ethiopia's output has risen at near double digit rates for a decade, luring investors from Sweden to China.

But economists warn that squeezing the private sector to pay for the public infrastructure could hurt future prospects. Growth is already showing signs of slowing.

Even so, Addis Ababa says the price is worth paying to guarantee Egypt has no veto over the dam, the centrepiece of a 25-year project to profit from East Africa's accelerating economic growth by exporting electricity across the region.

"We did not want this dam to suffer from external pressures, particularly with respect to financing," said Fekahmed Negash, a director within Ethiopia's Ministry of Water and Energy.

DIPLOMACY RECAST

Ethiopia's transformation from an economic disaster barely able to feed its people into an emerging regional leader capable of self-financing mega-projects has recast diplomacy over the Nile, northeast Africa's most important resource.

Egypt, which has claimed exclusive right to control the river's waters for generations, is fuming. Cairo worries the dam will reduce the flow on which it has depended for drinking water and irrigation for thousands of years.

It has demanded building be halted pending negotiations between the countries, and had offered to take on joint ownership of the project, an offer Addis Ababa dismissed.

Cairo no longer wields the same leverage it once did when upriver sub-Saharan countries were too poor to build such huge projects themselves.

Still, the dam's cost of more than $4 billion is roughly 12 percent of the annual output of Ethiopia, a steep price to pay for a country spurning outside help.

Ethiopia has resorted to measures like forcing banks that lend to private borrowers to lend the equivalent of 27 percent of their loan books to the government at a low return, effectively a tax on private lending.

Along with other projects, the dam is draining so much financing from the economy that private investors' access to credit and foreign exchange is being jeopardised, hurting growth, the International Monetary Fund says.

The IMF forecast in November that output growth would slow to 7.5 percent this fiscal year from 8.5 percent in 2011/12, and said the economy needed restructuring to encourage private sector investment now crowded out by huge public projects.

Ethiopia needs high growth to fulfil plans to lift its population out of deep poverty. Per capita income was still just $410 in 2012, the World Bank says.

The government disputes the view that lavish public spending is hurting overall economic performance, and forecasts a higher growth rate than the IMF.

Italy's biggest construction firm, Salini Impregilo , which is building the dam, says all payments have been made on time so far and it has no worries about Addis Ababa continuing to come up with the needed billions.

"We have full confidence in the government of Ethiopia," the firm said in an e-mail to Reuters.

And the dam is just the start for Ethiopia's ambition of becoming a regional power hub. A government plan seen by Reuters would see Africa's second most populous nation target installed capacity of 37,000 MW within 25 years - far more than the World Bank's estimate of just 28,000 MW for the entire current output of sub-Saharan Africa excluding South Africa.

More dams are being built and Prime Minister Hailemariam Desalegn is fast securing deals to sell power abroad.

In the Ministry of Energy, a building whose stark design is a throwback to when communists ran Ethiopia's economy into the ground, a poster maps Ethiopia's energy goals.

From a dot on the Nile, lines run north through Sudan and across the Sahara desert as far as Morocco while extending southwards to South Africa, linking Kenya, Rwanda, Tanzania and other power-hungry economies.

Djibouti, Kenya and Sudan already take 180 MW, which, though a small amount so far, is already changing the economics of electricity in the region, Ethiopian officials say.

"Before it started getting power from Ethiopia, Djibouti's tariff was 30 U.S. cents per kilowatt hour. We are selling to them at 6 cents," said Mekuria Lemma, corporate planning chief at Ethiopia's state-run power corporation, EEPCO.

Kenya has signed an agreement to buy about 400 MW. Rwanda too inked a deal in March to take 400 MW by 2018 and a similar arrangement with Tanzania is expected. Beyond Africa, talks are expected over supplying 900 MW to Yemen via an undersea cable. - Reuters