Residents do their washing in the Irrawaddy River in Myanmar, where a Chinese dam construction project has been delayed due to environment concerns. Getty Images
MYITSONE, Myanmar—Tucked between lush green hills in this northern Myanmar town, the site of the stalled $3.6 billion Myitsone dam project is deserted, peaceful and quiet.
But the debate surrounding the dam's future has grown loud. Residents and activists concerned about the project's impact on the environment are fighting to permanently shut it down, while the dam's Chinese developers are pushing to restart work on the expensive structure.
The dispute has left Myanmar's government in a bind: Although it wants to honor contracts with foreign investors, it is also under pressure to prove that it is evolving into a functioning democracy that responds to its citizens' concerns.
The issue has also turned into a domestic power play. Opposition leader Aung San Suu Kyi is using the uncertainty surrounding the project—suspended by the government in 2011 after Myanmar's reformist president, Thein Sein, took power—as a criticism of the current government, accusing the administration of ducking responsibility.
"Questions about the project should only be asked to the president," said Ms. Suu Kyi last month on a visit to the southern state of Karen. She didn't explain her own position on the project.
The trip, her first to the state since she was released from house arrest in 2010, was widely seen as part of a campaign in advance of the 2015 elections to drum up support from ethnic minorities.
In comments to local media in January, she accused the government of "not being brave enough" to make a decision on the project, which is only 5% complete. The developer says it is losing $50 million a year on the project.
Mr. Thein Sein says he won't restart the project during his term, nor cancel it for good. The suspension sent a signal to the West that Myanmar was getting serious about reform, but it put a kink in the new administration's ties with China, a longtime ally. The dam's developer, state-owned China Power Investment, hopes to restart construction when Myanmar's next government takes over in 2015—which could be Ms. Suu Kyi's National League for Democracy.
The party has swept every election it has contested, most recently the 2012 by-elections in which it won 43 out of 44 seats available, and is a symbol of democratic reform. But the party has almost no experience with governing or diplomacy.
Across Southeast Asia, energy demand is soaring, but many big hydropower projects have been stalled or canceled across because of resistance from residents and activists concerned about environmental damage. While hydropower projects offer an opportunity for rapid development—Myanmar would bring in $54 billion in tax payments, more than its 2011 gross domestic product—the dam builders are viewed suspiciously by communities whose land has been taken away with little compensation.
Analysts say resuming the project could undermine Myanmar's reputation as a rising star in the international community. The former pariah state has won praise for its transition toward democracy, and the suspension of the dam project was followed by former U.S. Secretary of State Hillary Clinton's first visit to the country. Most of Myanmar's political prisoners have been released, activists are campaigning against government policies for the first time in decades, and many investors now see the country as a frontier for everything from telecommunications to oil and gas.

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But the project's continued suspension could damage Myanmar's relationship with China, which has bristled at Myanmar's warming ties with Western powers. Since 2011, Chinese investment in the country has fallen sharply—from US$12 billion between 2008 and 2011, to just US$407 million in the 2012 fiscal year ending in April 2013.
"This is an important project for both the Myanmar government and the Chinese government," Li Guanghua, managing director of China Power Investment said in an interview.
Mr. Li and other China Power executives have spent months trying to convince Myanmar government officials, residents and other stakeholders that their project offers benefits.
In late December, the company released its first social-responsibility report saying the project won't cause major environmental damage. The report, commissioned by the investors behind the project, including Myanmar's Electrical Power Ministry and Asia World conglomerate, also suggested that the dam could create 40,000 local jobs.
In an attempt to compensate residents who have to be relocated to make way for construction, the Chinese company is offering 100,000 kyats each, or about $100, and has built model villages at a site about half an hour away. Three hundred households were relocated initially, but residents are worried that 15,000 more or so will have to be moved if the dam is restarted.
China Power representatives say they are offering workers a chance to improve their skills. Most residents and civil society groups remain unconvinced.
"We don't want their compensation," said Dau Nyoi, a social worker and environmental activist in Myitkyina, Kachin state. "Money can be spent in days. This is about our livelihood that they are taking away."
Ms. Dau Nyoi and other activists say that the dam would take away fertile farming land from the area's largely agricultural communities. Kachin residents also resent that a vast majority of electricity produced—about 90%—would be funneled toward China's Yunnan state, and that areas around the dam would be susceptible to flooding.
The Chinese company, though, says that the 21 gigawatts of electricity that would be produced each year—about 11 times the current yearly electricity consumption of the whole of Myanmar—would lift the standard of living in a country where poor infrastructure remains a hurdle for even the most enthusiastic foreign companies.
"We have worked on hydropower projects in 12 countries…but have never faced anything like we have in Myanmar," said China Power's Mr. Li. "Without electricity, there can be no development or international investment."