BANGKOK (Reuters) - Thailand's government should significantly raise subsidies for local firms participating in its procurement system to help manufacturers suffering from a flood of cheap Chinese imports, the head of its top business group said on Tuesday.

The influx of Chinese products has added to challenges facing Thailand's stuttering economy, the second largest in Southeast Asia, with recorded growth of just 1.5% in the first quarter and saw nearly 2,000 factory closures in the past year.

Small- and medium-sized enterprises (SMEs) have been hard hit, with less than half of Thailand's 3.2 million SMEs able to access loans from financial institutions.

Those that manufacture in Thailand and participate in state procurement bidding receive a 5% subsidy currently, giving them a slight advantage over foreign firms, but not enough to make a difference, said Kriengkrai Thiennukul, chairman of the Federation of Thai Industries (FTI).

"We need to lift this temporarily for 2-3 years from 5% to 20%," he told Reuters in an interview.

"This will be real money circulating in the system that could boost the economy significantly."

The subsidy system implemented last year has helped local SMEs secure a 15% market share of state procurement, earning them 102 billion baht ($2.9 billion) so far, said Kriengkrai, whose federation represents more than 16,000 private firms and lobbies the government on their behalf.

The FTI is seeking to increase that market share to 30% to 50% this year, he added.

The government needs to better protect local businesses in the long term, otherwise they will not survive "a tsunami" of cheap goods from China, Kriengkrai said.

Thailand last month started collecting a 7% value-added tax on imported goods priced less than 1,500 Thai baht ($42.65), mostly from China, but such products are still exempted from customs duties.

Prime Minister Srettha Thavisin says he is committed to supporting small firms and on Tuesday ordered authorities to scrutinise import licenses and tax regulations to help Thai SMEs.

Up to June this year, more than 660 factories, mainly from the SME sector, shut down in Thailand, an 86% increase compared to the same period last year, Kriengkrai said.

"We may be getting more investment from overseas in new industries," he said. "But at the same time, Thai SMEs are closing down like falling leaves."

($1 = 35.1700 baht)

(Reporting by Panu Wongcha-um; Editing by Devjyot Ghoshal and Martin Petty)

By Panu Wongcha-um