SINGAPORE (Reuters) - Ten Southeast Asian leaders signed a historic charter on Tuesday that aims to create an economic bloc encompassing a half-billion people, but controversy over Myanmar threatened to spoil the ASEAN party.

Under the crystal chandeliers of the Shangri-La hotel ballroom, Singapore Prime Minister Lee Hsien Loong was first to sign the charter that enshrines democracy and human rights.

He was followed by the leaders of the young democracies of Indonesia, Malaysia, the Philippines; the leaders of one-party states Laos, Cambodia, Myanmar and Vietnam; the absolute monarch of Brunei and the head of the government the Thai military installed after overthrowing a democratically elected government.

"The new charter will be of benefit to all members. It is a historic moment, because the new charter will address ongoing challenges and opportunities," Indonesia's President Susilo Bambang Yudhoyono told Reuters as he walked the red carpet.

Myanmar Prime Minister Thein Sein stood stiff and stern throughout the ceremony of the 13th ASEAN summit. Of the other leaders, only Philippine President Gloria Arroyo managed a smile.

They may have had reason to be glum.

The United States warned on the eve of a summit to mark the group's 40th anniversary that further inaction on Myanmar could cost ASEAN a free trade deal, the EU tightened sanctions on Myanmar, and Arroyo broke ASEAN ranks by saying the Philippine Congress might not ratify the charter if Myanmar did not move towards democracy.

ASEAN Secretary-General Ong Keng Yong acknowledged Myanmar had been a distraction at a summit meant to celebrate ASEAN's new status as a legal entity.

"We don't want to come across as being too confrontational in a situation like this," Ong told reporters. "What is important is we want to focus our summit on our charter ... and our commitment to do the economic community, so we don't want it to be a big distraction."

ASEAN diplomats say the group is grappling with a dilemma. On the one hand, Myanmar's membership is complicating its efforts to create a powerful and influential bloc in a globalised world. But shoving the junta beyond the pale would drive Myanmar further into China's embrace.

"It's been a buffer state between China and India," said Tony Regan at consultancy Nexant. "The ASEAN policy was to take on Myanmar as a friend and therefore make it less vulnerable and less paranoid. Now they have a credibility problem."

FREE TRADE BLOC

The charter calls for a free-trade economic bloc by 2015, including open movement of goods, services and investments, and freer flow of labour and capital. But a full EU-style integration or common currency is not on the cards.

"ASEAN, after 40 years, now has a legal entity, an institutional structure and a clear roadmap," Indonesian Trade Minister Mari Pangestu told Reuters at the ceremony.

But she said the ASEAN Economic Community is aimed more at creating a single production base than a single market.

ASEAN will discuss free trade with leaders from China, Japan, South Korea, India, Australia and New Zealand on Wednesday at the "East Asia Summit".

Critics say that despite strong economic growth in all ASEAN member countries, regional trade has shrunk as China's rapid growth forces former Southeast Asian tigers such as Malaysia into an old role as plantation economies and suppliers of raw materials and half-finished goods.

Territorial disputes, rivalries and vastly different legal systems pose big obstacles to becoming a coherent bloc.

As ASEAN ministers signed the blueprint, Singapore state holding company Temasek was involved in a regional legal tussle after Jakarta declared its investments in Indonesian telecoms were in breach of anti-monopoly laws.

"It's a good example of why full ASEAN integration remains a pipe dream," Citigroup economist Chua Hak Bin said.

While the charter aims to promote "the rule of law, good governance, the principles of democracy and constitutional government", national sovereignty trumps all.

Asked why a one-party state would sign a charter that aims to strengthen democracy, Vietnam's Prime Minister Nguyen Tan Dung underlined the charter's principles of non-interference.

"The one-party system is the choice of the Vietnamese people. I don't think there should be any imposition from any countries," Dung told Reuters on Monday.