* China and Japan had been vying for $5 billion contract
* Strong FDI has been bright spot for struggling economy
* Jakarta decided at last minute it didn't need high-speed train
* China appears favourite for medium-speed rail project
* Indonesia still wants high-speed Jakarta-Surabaya link (Adds SOE minister, details)
By Kanupriya Kapoor and Gayatri Suroyo
JAKARTA, Sept 4 (Reuters) - Indonesia's 11th-hour decision to scrap plans for the nation's first high-speed railway has sown confusion among top investors China and Japan, potentially undermining the strong foreign investment that has been a rare economic bright spot.
China and Japan had been battling over the multi-billion dollar contract, until it was abruptly pulled in what appeared to be the latest in a series of regulatory flip-flops and erratic policy-making moves under President Joko Widodo.
Indonesia's chief economics minister was left to explain to the two Asian giants on Friday the reason why Jakarta decided at the last-minute that the bullet train project was the wrong option for Southeast Asia's largest economy.
"It looks like a sudden move because the recommendation was made after a review of both proposals," Teten Masduki, presidential chief of staff, told Reuters. "But the recommendation is in the best interest of the country."
Tokyo and Beijing had lobbied heavily for the $5 billion contract, each sweetening the terms of their bids up until Monday's deadline.
Analysts believed that whoever had won would likely have been the front-runner for future high-speed rail projects in Asia, including one linking Kuala Lumpur and Singapore.
"It was the recommendation from independent consultants that suggested to the government that a medium-speed rail was a better option because the cost is cheaper and the time of the journey isn't much longer," Masduki said.
President Widodo announced late Thursday that a bullet train between the capital Jakarta and the textile city of Bandung was unnecessary, since it would never reach its maximum speed of more than 300 km (188 miles) per hour in between station stops.
The administration instead advocated a slower train for the 150 km journey and asked China, Japan, and others to submit new proposals. The government is expected to finalise details of the new project this month with the aim of starting construction by the end of the year.
China appeared on Friday to be the favourite for that contract.
"Japan's proposal includes a request for a government guarantee. Meanwhile China doesn't require that. That's the main difference," State-owned enterprises minister Rini Soemarno told a news conference.
"So if Japan wants to stay in the process they must get rid of the requirement for government guarantees and government loan to SOEs."
The bullet train was initially intended to be the first phase of a 763 km rail link connecting Indonesia's two biggest cities, Jakarta and Surabaya.
The presidential palace said it still wanted to build a high-speed railway that covers the length of Java island, home to more than half the population of the sprawling archipelago.
A Chinese embassy official in Jakarta declined to comment until more information was provided by Indonesia.
"The project was a priority for China because it would have been one of the first and most visible manifestations of President Xi Jinping's 'One Belt, One Road' overseas investment drive," said Tom Rafferty, Beijing-based analyst at the Economist Intelligence Unit.
"The decision therefore seems likely to dim China's confidence in the Indonesian market."
Yasuaki Tanizaki, Japan's ambassador to Indonesia, told reporters on Friday that he had "expressed my regrets" over the decision, but added he did not think it would affect Japan's investment in the country. He said Tokyo was waiting for details on the medium-speed rail project before deciding whether to participate.
The road to Thursday's decision was particularly bumpy for Tokyo, which had initially believed it won the contract in March after completing a more than $3 million feasibility study. But Indonesia decided to invite other offers in order to get the best deal. (Additional reporting by Nicholas Owen and Cindy Silviana; Writing by Randy Fabi; Editing by Alex Richardson)