* North Korea says Chinese firm failed to honour investment contracts
* Rare attack on China by North Korean official and state media
* Move comes as North Korea's leader asks for China visit
* Xiyang tells Reuters it was "cheated", says Beijing's policy wrong
* Attack shows North Korea's unease over China dependency-analysts
By David Chance and David Stanway
SEOUL/BEIJING, Sept 5 (Reuters) - North Korea attacked charges on Wednesday that it was a "nightmare" to do business in, complaints that threaten desperate attempts to boost investment from solitary ally China to help repair its broken economy.
The extremely unusual attack underlines the reclusive state's sensitivity over an increasingly heavy dependence on China and comes as Pyongyang's new leader Kim Jong-un seeks a state visit to Beijing to plead his case for investment .
The rebuttal, in a statement on North Korean state news agency KCNA, follows very public comments by Chinese miner and steel manufacturer, the Xiyang Group, which described its investment in an iron-ore powder venture there as "a nightmare", accusing the North of violating its own investment laws.
Xiyang told Reuters in an interview after the North's statement that it had been "cheated" and it lambasted Beijing's policy of propping up North Korea's unreformed regime which it said that it was done for geo-political reasons.
"It (Xiyang) has carried out only 50 percent of its investment obligations though almost four years have past since the contract took effect," KCNA quoted a spokesman for North Korea's Commission for Joint Venture and Investment as saying.
Xiyang refused to curb its criticism of North Korea when it spoke to Reuters, suggesting that Beijing was doing little to help companies that ran foul of what it viewed as arbitrary rulings by North Korean officials.
"This isn't just about us - it is about all companies investing in North Korea," Wu Xisheng, vice general manager of Xiyang told Reuters.
"They just don't have the conditions for foreigners to invest. They say they welcome investment but they don't have the legal or social foundations."
The complaints underline the difficulty of doing business in one of the world's most isolated and impoverished countries.
And they come amid a welter of criticism of the North, whose economy is smaller than it was 20 years ago according to United Nations data, and where hard-nosed Chinese businessmen have to contend with Beijing's desire to prop up its ailing neighbour.
"The Chinese government can do nothing - it is thinking more about political stability," said Xiyang's Wu.
Asked about the issue, China's Foreign Ministry spokesman Hong Lei gave a muted response, saying the government continued to encourage Chinese companies to invest in North Korea.
"Regarding some problems that occur in the process of China-North Korea cooperation, we hope the two sides can appropriately handle and resolve them," he told a regular news briefing.
North Korea almost never criticises its neighbour or any Chinese entities in public. The KCNA article said the comments had been whipped up by "hostile forces" in an orchestrated media campaign to blacken the isolated state's name.
North Korea has for years pursued a "military first" policy that critics say has impoverished its people while developing one of the world's largest armed forces and spending money on developing a nuclear deterrent.
It has been it sanctioned and largely cut off from the international economy in punishment for its nuclear programme.
Despite sitting on potentially trillions of dollars of mineral reserves ranging from gold, to iron ore and rare earths as well as uranium, all but the bravest investors have been deterred by a North Korea's toxic economic environment.
Between 2003 and 2009, Chinese investment in North Korea stood at $98.3 million, just 12 percent of the amount Chinese firms have invested in South Korea, according to Chinese data cited in a 2011 report by Drew Thompson, a Korea specialist who now works at the U.S. Department of Defense.
Thompson said in his report, the most detailed on the subject, that Chinese investments were "smaller and less successful than projects in neighbouring states" due to "rent seeking, poor infrastructure and the oppressive political environment".
A recent trip by Reuters to Dandong, a Chinese town on the North Korean border, showed that while traders were hopeful of an opening under Kim who is believed to be in his late 20s and became the third of his line to rule, little had changed.
"I sell mainly autos and from what I see every year they buy fewer and fewer. The demand there gets smaller every year," said a trader in Dandong who refused to give his name due to the sensitivity of the cross-border trade.
North Korea's official ideology is based on economic self-dependence but in reality it has been unable to feed its population for decades, plant and equipment lies idle due to lack of electricity and much of it is too old to be of use.
Adding to its problems, reports are increasing that this year's grain harvest, never enough even in good years, has been badly hit by poor weather.
Sanctions, the collapse of the Soviet Union and a freeze in relations with prosperous South Korea have forced it into China's arms and in 2011, 89 percent of the North's trade was with its powerful ally, exluding operations in an economic zone with South Korea, which is counted as internal Korean trade.
"Kim Jong-un more than any of his predecessors needs economic success for his political legitimacy. This implies measures to make the economy more efficient - i.e. reforms," said Frank Rudiger a professor at Vienna University and an expert on North Korea.
"As much as they need it... North Koreans are very, very suspicious of the massive onslaught of Chinese investment, trade, business people, goods and services," he said.
Stung by the Xiyang criticisms the investment authority statement on Wednesday said there would be more reforms to "ensure the legitimate rights and interests of all investors", but it did not specify what those reforms could be.
Earlier this year, Pyongyang unveiled new investor incentives for the Rason economic zone that sits next to China, including longer leases, the right to choose who to hire and what to pay them, as well as tax incentives.
This was the sixth revision to the laws governing Rason since its inception in 1993, according to specialist North Korea website 38North (www.38North.org) and a separate announcement on Wednesday that the North's rubber stamp parliament would hold a second session in September could mean more reform measures.
However, there is a limit as to how far Pyongyang is prepared to liberalise, fearing that unfettered investment could destabilise the Kim dynasty.
Last month, Jang Song-taek, Kim's uncle, visited Beijing to ask for new investment and to try to get China to agree to a state visit for the new leader.
China has not responded to the requests and the North's attack on a company linked to the government of a Chinese state bordering North Korea could make Beijing think twice about relations with its neighbour which irritated its backer with its two nuclear tests and a failed rocket launch in April.
"Coming in the wake of a pretty unsatisfactory visit to China by Jang Song-taek, this is a very public message of excuse as well as pressure that shows it does not like being humiliated and that North Korea is not a vassal of China," said Yoo Ho-yeol expert on North Korea at Korea University outside Seoul.