JAKARTA, Jan 28 (Reuters) - Indonesia's financial markets took heart on Wednesday from the government's latest reform measures in thin trading ahead of the country's major festival.

But attacks by hundreds of Islamic school pupils in two small Central Java coastal towns this week were a further warning to the authorities of the tensions aroused by Indonesia's worst economic crisis in decades.

A duty policeman at Rembang said the situation was back to normal after rioting in Kragan on Monday night and Sarang the following night in which a total of 20 shops and a house were damaged.

"There were no arrests and no casualties," he said, adding that the damage had been done by about 800 pupils from local Islamic boarding schools. Other sources said the buildings were owned by ethnic Chinese, who are frequent targets in times of economic hardship and unrest.

Islamic boarding schools are a prominent part of rural Java, educating millions of youngsters easily swayed by sometimes fiery anti-Chinese rhetoric by some Moslem teachers.

The government announced further measures on Tuesday to overcome the economic crisis that has sent prices and unemployment soaring in the country of 200 million people.

The battered rupiah currency, which at its worst has dropped over 80 percent in value against the dollar since last July, continued to strengthen on Wednesday on the reform news.

Spot rupiah closed in Jakarta at 9,850/10,800 after opening at 10,500/11,500, while the stock market ended a shade over two percent higher at 485.94 points.

Millions of Indonesians have spread out through the archipelago in one of the world's biggest annual movements of people to celebrate the Eid Al-Fitr festival marking the end of the Moslem fasting month of Ramadan.

The government is concerned over the potential for unrest through the vast nation stretched for 5,000 km (3,000 miles) along the equator and straddling major East-West trade routes.

There were riots over rising prices in several East Java towns earlier in the month and panic buying in a number of cities including Jakarta, but the country so far remains stable.

Financial markets are basically closed until next Monday, when the government will see how the international financial community has accepted its economic reform plans and a proposal for a voluntary pause in payments on its crippling corporate foreign debt.

"This is a good package in has a lot of positives in it, we just have to know the details and how they're going to do it," on Western banking analyst said.

Economic analysts said President Suharto appeared to be committed to forging ahead with sweeping economic reforms agreed with the International Monetary Fund (IMF) in return for a $43 billion bail-out.

But analysts said the key issue of a successor to the 76-year-old leader had still to be resolved, and this was a major element in investor uncertainty over the country's future.

Suharto himself has said he would seek a seventh five-year term in office in March, despite unprecedented calls for him to step down at the end of his current term.

Analysts noted, however, these calls had become more muted as Suharto appeared to exert his leadership to overcome the crisis, which threatens the economic development he has proudly presided over during the past 30 years.

"Now the economic situation is being worked out, you've still got the political situation, and that's a race against time," one analyst said.

The focus of attention is who Suharto will accept as his vice-president and potential successor. Several names have surfaced, but the president has given no clear indication who his choice might be.

The reforms announced on Tuesday included desposit and credit guarantees for the country's commercial banks, opening them up to foreign ownership, and a new institution to deal with failing banks.

Analysts said a notable absence from the proposals was reform of the country's commercial code, including a viable bankruptcy law to engender confidence in foreign investors.

A contact committee of international banks has been formed to represent lenders to Indonesia's corporations and a steering committee of borrowers are being set up to deal with a crippling private sector foreign debt estimated at at least $66 billion.

The collapse in the value of the rupiah has left most companies technically bankrupt and unable to repay their loans.

The two groups working on a repayment framework are expected to get down to business next week, but some bankers have warned the process could be a long one and not all creditors might get paid.

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