* Asmara facing sanctions on mining, remittances
* Country already hit with assets freeze, arms and travel embargo
* Red Sea state says Ethiopia dirtying its name
By Aaron Maasho
ADDIS ABABA, Nov 18 (Reuters) - Eritrea has a strong chance of heading off new sanctions that could cripple the Red Sea state's economy even though it remains far from persuading its neighbours and the United Nations that it is not a destabilising force in the volatile Horn of Africa.
The United Nations is mulling more punitive measures against the secretive government of President Isaias Afewerki that include sanctions on the impoverished country's nascent mining sector and remittances sent from abroad -- both key sources of foreign exchange.
But Western nations see those sanctions hurting the population more than the government, while analysts say others including China and Russia typically oppose sanctions on African nations.
Asmara is long accused of arming and bankrolling al Qaeda-linked Islamist militants fighting to topple Somalia's Western-backed government and is now squaring up to Kenya after it deployed forces into it lawless neighbour five weeks ago.
Championing the new sanctions is Eritrea's neighbour and arch foe Ethiopia.
The draft resolution was submitted to the United Nations Security Council in the wake of a U.N. report in July that said Eritrea plotted to attack an African Union summit in Ethiopia in January and was sending funds to the militants via its embassy in Nairobi.
Kenya this month accused Asmara of flying a cache of weapons destined for the insurgents into central Somalia. Eritrea denied the allegation and said it was neither an enemy of Kenya nor a sponsor of al Shabaab.
In spite of a widespread and deep mistrust of Eritrea's dealings in the Horn of Africa, the latest round of sanctions are likely to be rejected by the Security Council, or at the very most softened up.
"It's not that we approve of the Eritrean government, but we don't think sanctions that would hit the Eritrean people would be very helpful," a Western envoy to the U.N. Security Council told Reuters.
"Sanctioning the mining industry and remittances would hurt the Eritrean people far more than the government," he said.
The envoy said sanctions against Eritrea's main source of income would be "counterproductive" and would "probably not be approved by the council".
Further sanctions would come on top an arms embargo, travel restrictions and assets freeze imposed in 2009.
David Shinn, a former U.S. ambassador to Ethiopia said China and Russia among others were likely to push for a watered-down resolution.
Both China and Russia typically oppose sanctions on African nations, a position that left China in particular in a bind.
"While it has cordial relations with Eritrea and opposes sanctions, it has much more important ties with Ethiopia," Shinn told Reuters.
"Something will probably come out of the United Nations Security Council, but I believe it will be fairly mild."
Eritrea says Ethiopia is deliberately dirtying its name to distract world attention from a festering border dispute between the two nations. It's reputation as the region's bad boy is unjustified and unfair, it says.
"This long history of allegations against Eritrea is Ethiopia's fabrication. They want the world to forget their occupation of Eritrean territory and they want to weaken the government," Eritrea's ambassador to Kenya, Beyene Russom, told Reuters.
"We are trying to clear our name against all these allegations in the U.N. Security Council. We are not being given the right to defend ourselves," he said.
Ethiopia brands Eritrea a regional threat.
The normally reclusive Isaias has in the past months embarked on a rare round of shuttle diplomacy across Africa and in New York to drum up political support.
Known better for his brash criticism of the West and a penchant for shunning diplomatic niceties, Isaias sought Eritrea's re-entry into the regional IGAD bloc in August, after walking out four years ago in protest of Ethiopia's deployment of troops inside Somalia at the same time.
Isaias has travelled to Uganda, hit last year by a devastating twin-bomb attack claimed by al Shabaab to avenge Kampala's peacekeeping force in Mogadishu and Equatorial Guinea, whose leader is current chair of the African Union.
The 65-year-old leader, who is widely criticised by foreign powers and rights groups for the political and religious repression of his people, has also requested an audience at the Security Council to defend his case.
"Eritrea is seen by African countries as a pariah state. The government of Isaias Afewerki wants to change this perception," said Shinn.
Eritrea appointed in January its first envoy to the African Union since 2004. Its effort so far to rejoin IGAD has met a brick wall.
"It is purely Ethiopia blocking our re-entry into IGAD. They don't want us there," said envoy Russom.
But Kjetil Tronvoll, a Horn of Africa analyst and human rights professor, believes the entire region remains sceptical over Eritrea's intentions.
"I think all countries in the region will be sceptical to this new initiative from Eritrea," Tronvoll said. "As long as its policies on the ground do not change, (any) re-entry into IGAD and the AU will not change the governments' perception of Eritrea that much," he added.
Ethiopia is an influential player in east Africa and the Horn of Africa. It has considerable military muscle and is seen by the West as a critical bulwark against Islamic militants spreading deeper into the region.
Eritrea and Ethiopia's bitter border dispute, which sparked a two-year war more than a decade ago that killed tens of thousands of troops, also triggered a tit-for-tat war of words, analysts say.
"Despite the possible creation of a facade of normalcy, there is virtually nothing to indicate that Eritrea might even remotely be interested in mending its international or diplomatic ways," Ethiopia's Foreign Ministry recently said of Isaias' travel spree.
"Indeed, if anything, Eritrea still remains as destructively intransigent as ever."
Asmara denounces such allegations as a "witch-hunt". (Additional reporting by Lou Charbonneau in New York and Richard Lough in Nairobi; Editing by Richard Lough)