By Marie-Louise Gumuchian and Ali Shuaib

TRIPOLI (Reuters) - The taxi driver parked outside a luxury hotel in Tripoli says most of his business there has ground to a halt in the past two weeks.

Since an attack on the U.S. consulate in Benghazi on September 11 killed the U.S. ambassador and three other Americans, heightening fears for the safety of Westerners in Libya, there have been fewer foreign customers requesting his services.

"There has been a change, the foreigners are much more cautious now," the driver, who did not wish to be named so as not to be recognized, said. "They won't just come up to the taxi rank, they want to be careful. Some have gone, others are staying inside the hotel. But they're not going out with us."

The assault on the U.S. diplomatic mission was the most serious security incident in Libya since the end of the eight-month uprising that finished Muammar Gaddafi's 42-year rule last year.

Coupled with a lull in policymaking as the country awaits a new government that will take over soon from the interim administration, the attack risks scaring off foreign investors in the short term. It will also pressure the new administration to focus heavily on security, which could further delay much-needed reforms and reconstruction in Libya.

Security has been an issue as the country's new rulers have struggled to contain armed militias who have refused to give up their weapons since the war ended.

The Benghazi attack has led many companies to beef up security measures in Libyan cities, restricting staff movements, and as embassies warn against non-essential travel to the North African country, risk premiums are rising.

"Suddenly you will have people who won't be able to come because of insurance - companies may not send them because they see Libya as too risky," one foreign businessman in Tripoli said. "That will slow things down. And for those who had plans to bring their families here, that will be postponed."

Libya had been making progress in trying to attract foreign investment and stimulate its private sector: officials have been working to update a 2005 banking law which first allowed foreign banks into the country and have plans to introduce Islamic banking.

International oil companies were the first to return to the country after the uprising, helping oil production return to almost pre-war levels of 1.6 million barrels per day.

But recovery has been prone to setbacks: in July around half of Libya's oil-exporting capacity was temporarily shut down after protests by groups demanding more autonomy for eastern Libya, the source of most of the country's oil.

Major construction and transport projects have been untouched since last year, awaiting the authorities' approval to resume.

"The incoming government's focus will be so much on security, which has always rightly been a priority but there is now an added risk that restarting essential infrastructure projects may be put down the agenda in the immediate term," said Alex Warren of research and advisory firm Frontier, which runs The Libya Report business website.

Benghazi air space was temporarily closed after the attack, expatriate workers in the eastern city were relocated to Tripoli or fled overseas, and a British trade delegation was cancelled.

"What happened in Benghazi has a very negative impact because it may lead foreign businessmen to freeze plans to come and invest in Libya," said Issa al-Babaa, executive director of the Libyan Businessmen Council.

Yet the country's tiny stock market has barely reacted, dipping less than half a percent in the two weeks since the attack, according to Ahmed Karoud, general manager of the stock exchange, which lists about a dozen local companies.

That suggests the Benghazi attack may not have a lasting impact on business and, like in Iraq, foreign investors in the longer term may be willing to invest there despite security concerns if they see high returns.

CRACKDOWN ON MILITIAS

Many investors, including Chinese companies expected to bid for infrastructure projects, may not be deterred as violence has been directed mainly at Western targets.

"Given the current state of the economy, I don't think it's affected the macro picture or overall GDP growth. Oil production and trade has not been disrupted, there are no tourists to scare off and foreign investment is minimal at the moment," said Warren.

"But it's going to make it more difficult to move away from those current dynamics. Sentiment has been affected and the government will have to work harder to persuade foreign companies to come to Libya in the short term, given the added risk they will feel is involved."

Keen to make a break from the Gaddafi regime, the interim government said no major new concessions would be awarded until after the national assembly elections that were held in July.

The International Monetary Fund forecast in July that Libya's gross domestic product would double this year after shrinking 60 percent last year, helped by rebuilding and the release of pent-up private demand.

The attack is unlikely to hurt growth when oil accounts for the lion's share of revenues.

Libya aims to raise its oil production to 1.8 million bpd next year, above levels seen before the uprising.

But no new exploration and production contracts are expected for at least a year before a clearer landscape emerges from the OPEC member's democratic transition.

Gaddafi isolated the economy from much foreign competition, reserving licenses and contracts for his own circle, which makes some sectors attractive now he is gone, including telecommunications.

There are only two mobile operators, Al Madar and Libyana, which are both state-owned and a number of foreign telecom operators have been eying Libya including Etisalat of the United Arab Emirates, Qatar Telecom (Qtel) and Saudi Telecom.

Business potential highlights a lack of infrastructure which the new government will quickly need to address. In 2010, 14 percent of people in Libya were using the Internet, according to the International Telecommunications Union, compared with 49 percent in Morocco, 37 percent in Tunisia and 27 percent in Egypt.

The stock exchange has wanted to attract more foreign investors to trade shares since it reopened in February after closing during the war, but says rules on bringing funds into the country need to be relaxed.

"We are waiting for the new government to be formed. Nothing is known until then and we hope it will be stronger in making decisions," said Karoud.

The killings in Benghazi fuelled public anger at the continued presence on the streets of armed units, driving an Islamist militia, Ansar al-Sharia, out of the city on Saturday while the army ordered unauthorized armed groups to leave public premises in Tripoli as leaders vowed to dissolve rogue militias.

Central Bank Governor Saddek Omar Elkaber said the crackdown would be positive for the investment climate.

"What happened at the consulate eats away at the trust that has been gained in Libya," he said. "The steps now being taken are the right ones, it will help renew the trust for foreign investors."

In Benghazi itself, birthplace of the revolution, recovery could take longer, delaying regeneration after decades of neglect under Gaddafi, who fashioned the capital Tripoli into his power base at Benghazi's expense, its residents say.

"The events (are) going to delay things even more. Things were starting to look on the up. That is going to set them back, which is unfortunate," said Richard Weeks, a British engineer who has lived in Benghazi for more than 20 years.

Libya's second city, Benghazi is a major oil port but many foreigners working there were evacuated after the attack. Even before that, the city had seen several attacks on Western missions and organizations.

"Libya needs foreign business partners," a European worker said as he left Libya temporarily following the attack.

"But when even friendly Arab businessman are planning to leave and there is no government support to foreign companies, there are a lot of question marks."

(Additional reporting by Peter Graff in Benghazi; Editing by Susan Fenton)