* Finance minister, 27 others face charges over dam deal
* Arrest may deepen divisions in ruling coalition
* Arrests over graft more common; convictions still rare (Updates with company and lawmaker comments)
By Duncan Miriri
NAIROBI, July 22 (Reuters) - Kenyan Finance Minister Henry Rotich was arrested on Monday on suspicion of financial misconduct related to the construction of two dams, an unprecedented detention of a sitting minister for corruption in a country notorious for graft.
The charges against Rotich stem from a police investigation into the misuse of funds in a dam project overseen by Italian construction company CMC Di Ravenna.
Rotich denied any wrongdoing in a large newspaper advertisement in March. CMC denied wrongdoing.
Rotich and 27 co-accused face eight charges, ranging from conspiring to defraud and financial misconduct, said Noordin Haji, the director of public prosecutions. The minister and other officials will have to resign immediately, he said.
Among the others charged are Paolo Porcelli, the Italian director of CMC di Ravenna; and Rotich's number two at the ministry, Kamau Thugge, the principal secretary.
"They broke the law on public finance management under the guise of carrying out legitimate commercial transactions. Colossal amounts were unjustifiably and illegally paid out through a well choreographed scheme by government officers in collusion with private individuals and institutions," Haji told a news conference.
The two dams were budgeted to cost 46 billion shillings ($446 million), he said, but the treasury borrowed 63 billion instead, needlessly ratcheting up Kenya's ballooning public debt, which stands at around 55% of GDP.
"This kind of crime and irresponsibility enslaves us with unnecessary debt and mortgages our future generations," Haji said.
Kenyan prosecutors have requested help from British and Italian authorities, Haji said, and more charges could result.
CMC di Ravenna told Reuters in March that it had received slightly more than $75 million in advance payments for the two dams, planned in western Kenya.
CMC said on Monday it had received no official communication from Kenya on the charges. "CMC is certain of the correctness of the work of the company and its representatives, both in Italy and abroad," said a CMC statement emailed to Reuters.
Market reaction to the news was relatively muted, with little change in the shilling or dollar bonds.
Rotich's indictment may also be seen as further evidence of growing distance between Kenyatta and Deputy President William Ruto.
Kenyatta appointed Rotich in 2013 at Ruto's request. Ruto has made clear that he expects to receive the ruling coalition's nomination for the presidency in the 2022, despite objections from some in Kenyatta's camp. Kenyatta will have served two terms and be ineligible to run again.
Earlier this year, Rotich's questioning by police infuriated politicians from Ruto and Rotich's powerful Kalenjin ethnic group. Their home area saw some of the worst violence after the disputed 2007 elections, in which 1,200 people died.
Ruto's supporters have repeatedly accused police and prosecutors of trying to derail his presidential ambitions, said Ngunjiri Wambugu, a lawmaker opposed to Ruto's candidacy.
"There was a lot of claims especially from the Ruto wing of (the ruling coalition) Jubilee that corruption was being weaponised against them. And there was a lot of vicious attacks," he told Reuters.
Haji warned politicians against using the case to score points. "There may be elements who may seek to exploit these indictments to instigate social unrest."
At the main office for criminal investigations, Ruto's allies scorned the charges.
"We are lying to the citizens of Kenya that we are fighting corruption," Kipchumba Murkomen, the Senate majority leader and a Ruto ally, told reporters gathered outside. "They know...very well that ultimately...these people will be free."
MANY CHARGED, FEW CONVICTED
Critics accused Kenyatta of failing to deal with corruption during his first term, despite his promises to do so when he was first elected in 2013. Now more people are being charged, but successful prosecutions are rare.
Hundreds of senior government officials and business people are already facing various charges related to corruption, including the chairman of the National Land Commission, the managing director of the Kenya Railways Corporation, the deputy chief justice, the CEO of Kenya Power and the head of Kenya Pipeline Company.
None of the bigwigs has been convicted.
Auditor General Edward Ouko has said his detailed reports on corruption are often ignored. Corrupt judges interfere with cases and the government's own anti-corruption watchdog built cases that were too weak to prosecute, Haji said last year.
"I would not be celebrating arrests. We need to see people in jail and we need to see what has been stolen recovered," said Samuel Kimeu, head of Kenya's chapter of Transparency International.
($1 = 103.2000 Kenyan shillings)
(Additional reporting by Katharine Houreld, Humphrey Malalo and George Obulutsa in Nairobi, Karin Strohecker in London and Stephen Jewkes in Milan Writing by Katharine Houreld Editing by Frances Kerry/Mark Heinrich)
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