* Increased demand, higher margins help reduce net loss

* Overall subscribers jump 26 pct (Adds details, background)

By Nadia Saleem

DUBAI, Oct 21 A jump in the number of subscribers and improved margins helped telecom operator Zain Saudi report a narrower third-quarter loss on Wednesday that matched analyst forecasts.

Zain Saudi, 37 percent owned by Kuwait's Zain, made a net loss of 223 million riyals ($59.5 million) in the three months to Sept. 30 compared with a net loss of 316 million riyals a year earlier, according to a bourse filing.

Four analysts polled by Reuters had on average forecast Zain Saudi would post a loss of 216.9 million riyals.

The company has yet to make a quarterly profit since launching services in 2008 and has battled to compete with better resourced rivals Saudi Telecom Co (STC) and Etihad Etisalat (Mobily).

Zain Saudi said increased demand, a better operational performance and higher gross margins helped reduce its net loss for the quarter.

Overall subscribers jumped 26 percent to 11.8 million at the end of the quarter from 9.4 million subscribers at the end of the same quarter a year earlier. Its Internet subscriber base also rose, up 79 percent from the same quarter of last year.

After prolonged lobbying, the telecom regulator in February said it would slash call interconnection costs, which were among the highest in the region, in a move seen helping Zain Saudi win market share.

High interconnection costs benefit operators with large market shares because more calls originate and remain on their network and they do not pay such fees on those calls.

In arbitration with rival Mobily over service contracts in 2008, Zain Saudi said it had filed a counter claim earlier this month for 29.9 million riyals after Mobily's revised claim of 2.10 billion riyals. Zain said it had an adequate provision of 1.9 billion riyals on its books for the dispute.

The arbitration is over the application of a 2008 contract for Mobily to provide services including domestic roaming and site sharing to Zain Saudi, which began commercial operations that year. ($1 = 3.7499 riyals) (Additional reporting by Matt Smith; editing by David Clarke)