KUALA LUMPUR (REUTERS) - Malaysia's government signed a pact on Wednesday with the country's richest state of Selangor to restructure the water industry as a lengthy spell of dry weather forced an end to a five-year feud over control of water resources.

Media reports said opposition-run Selangor won approval from the federal government to take over four water firms in exchange for compensation of 9.65 billion ringgit (S$3.7 billion), to their owners.

The owners include builder Gamuda, whose shares dropped 0.7 percent, and water services company Puncak Niaga, which initially jumped 3.3 per cent, in a stock market that was down 0.4 per cent. Both firms have strong ties to the ruling National Front coalition.

In exchange, the federal government got the state's approval to build a 3.8-billion ringgit water treatment plant that opposition leaders had argued would prompt a steep hike in water tariffs.

A government spokesman told Reuters the deal had been signed but could not immediately confirm the details.

Selangor Chief Minister Khalid Ibrahim signed the agreement with Prime Minister Najib Razak as a witness, state news agency Bernama said.

The deal comes after a month-long dry spell forced Selangor, which accounts for a fifth of Malaysia's economy and is a base for multinationals such as Western Digital and Panasonic Corp, to begin limited water rationing as levels in its dams plunged to critical lows.

Selangor has become a crucial political battleground. Ahead of elections last May, its leaders accused the ruling coalition of using water supplier Syabas to manufacture a water crisis and sow doubts in voters' minds over the opposition's competence.

The federal government said the state had jeopardised its water supply by blocking construction of the new plant.

Wednesday's deal comes as Mr Najib promotes a "National Reconciliation Plan", an effort to dampen an upsurge in racial and religious tension in the multiethnic country since the contested May election narrowly returned his coalition to power.

Defacto opposition leader Anwar Ibrahim is contesting a seat in Selangor next month in a duel that may pave the way for him to become the state's next chief minister, giving him a potentially crucial power base ahead of the next election.

Wednesday's price is nearly double the first offer of 5.7 billion ringgit that Selangor state made to the firms in 2010.