Five men were shot dead in police raids on Sunday on the island where nightclub bombings in 2002 killed 202 people - mostly foreign tourists - and forced the world's largest Muslim country to confront violent Islamist groups on its soil.

Pictures of a villa where some of the men were shot dead, showing pools of blood on the floor of a garden hut, starkly illustrated the return of violence to the mostly Hindu island where militants last launched deadly bomb attacks in 2005.

Ansyaad Mbai, head of Indonesia's National Counter Terrorism Agency, said the men had plans to bomb targets on the island, including the beach-front "La Vida Loca" bar. Police initially said the suspects were planning armed raids on money changers, jewellers and the bar, partly to raise money for future attacks.

"This group was planning not only armed attacks against those targets but also bombings," Mbai said.

"At this stage we could not be sure of the scale but high or low, bombs are dangerous, especially in Bali. The impact would be huge," he added.

Attacks in recent years have mostly been small-scale, but the latest plot suggests terror groups may be trying to raise their profile at a time when Indonesia's economy is booming and it aims to play a bigger role on the world stage.

Bali held a high-profile regional summit last November attended by U.S. President Barack Obama and Secretary of State Hillary Clinton, among other leaders, and is scheduled to host the Asia-Pacific Economic Cooperation summit next year.

LATENT THREAT

Indonesia has scored notable successes in its battle against Islamic militancy since the 2002 bombing, arresting about 600 suspects and heavily disrupting the activities of the Jemaah Islamiah JI.L group and its offshoots that police said had carried out the attacks.

But there has been a steady stream of violence as militants have reacted to the crackdown by splitting into smaller groups and targeted security forces and government officials.

Police officers were attacked last year in a mosque suicide bombing, drive-by shootings and by an attempt to poison drinking water - low-cost operations that require relatively little expertise and allow for easier recruitment.

"It just shows there is a latent threat in the background and it's consistent," said Kevin O'Rourke, a political risk analyst based in Jakarta. "The good thing is that the authorities have a pretty good track record, especially over the last two years in anticipating and preventing attacks."

There have been no large-scale attacks on Western targets in Indonesia since 2009 when suicide bombers blew themselves up in two Jakarta hotels, killing nine people and wounding 53.

Prosecutors scored a major success last year when JI's spiritual leader, Abu Bakar Bashir, was jailed for 15 years, following years of efforts to obtain a long sentence for the 73-year-old preacher seen as inciting hatred in his speeches.

Improved investigation and surveillance techniques by the "Detachment 88" police anti-terrorism squad, funded by the United States and Australia, have been credited for breaking up several plots - including the latest one in Bali.

Initial findings by investigators in Bali appear to highlight the fluid and unpredictable nature of militant groups in Indonesia, which has become an emerging-market darling of investors in recent years.

Police said that the men, aged between 27 and 32, were linked to an armed robbery group in northern Sumatra island and the so-called Solo group, which police say was behind a suicide bombing at a church last year and other attacks in central Java.

Mbai said no explosives had yet been found but that there was evidence the group had surveyed their targets, taken photographs and "analysed the impact". An unknown number of suspects had escaped, officials said.

NEW CELLS KEEP SPROUTING

Andi Widjajanto, a defence analyst from the University of Indonesia, said the group appeared to be a "dormant cell" related to JI's top bomb-maker, Dulmatin, who was killed by police in 2010.

Mbai said that some of the suspects were involved in gangs with links to narcotics distribution, adding to evidence that terror groups are increasingly funding themselves through criminal activities such as robberies.

"Indonesia's government has been very successful preventing terror attacks. The special anti-terror detachment has built a much better capacity in recent years, but it has been failing to completely stop or erase new cells," Widjajanto said.

He said the authorities were still falling short in efforts to disengage militants from terror groups and to plug the flow of smuggled weapons through the country's vast, porous borders.

As the JI group has been broken up, suspicion of involvement in attacks has fallen on the Jamaah Ansharut Tauhid JAT.L group, which was established by jailed cleric Bashir in 2008 with the stated aim of creating an Islamic state through peaceful means.

Police have accused several JAT members of involvement in attacks. Last month, the United States designated the group a foreign terrorist organization, raising pressure on Indonesia's government to take a tougher line on the 1,500-strong preaching organization.

"It says it is peaceful but it is the most violent terrorist group in Southeast Asia," said Rohan Gunaratna, head of terrorism research at Singapore's S Rajaratnam School of International Studies.

"It is a terrorist organization that at times masquerades as a political and religious organization."

Son Hadi, JAT's spokesman, denied the legal group was related to terrorism, saying the accusations were a ploy led by the West to undermine the Islamic group.

(Writing by Stuart Grudgings; Editing by Mark Bendeich)

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