BOGOTA, July 4 (Reuters) - Colombia's rescue of Ingrid Betancourt shows Latin America's oldest insurgency is on the brink of defeat in its cocaine-financed war for control of the country, even though the group could take years to die out.

Wednesday's rescue of French-Colombian politician Betancourt, three Americans and 11 Colombians held for years in the jungle immediately boosted confidence in the Andean nation as the peso currency surged along with the local stock market.

"This was the worst blow to the morale of the rebels ever," Alvaro Jimenez, an ex-member of the demobilized Colombian M-19 guerrilla group, said. "But that does not mean the war is over. The death throes of this conflict could be very prolonged."

With this and other recent strikes against leftist FARC rebels, U.S. ally President Alvaro Uribe has crowned his success at improving security in the industrialized north of the country, which is attracting record foreign investment.

But conditions in other parts of the country of 44 million people may still help guerrillas limp along for years more, nourished by the cocaine trade and rural underdevelopment that breeds a steady pool of young, resentful recruits.

Real stability hinges on defeating the thriving drug business. Cultivation of coca plants used to make cocaine rose 27 percent last year and Colombia remains the world's No. 1 exporter even as the the guerrillas' power has waned.

Billions of dollars in U.S. military aid and Uribe's unflinching offensive has the Revolutionary Armed Forces of Colombia, or FARC, reeling and unlikely to recover as a coherent national force capable to challenging the state.

The killing earlier this year of two FARC secretariat members, one betrayed and dismembered by a bodyguard motivated by a government reward, ended four decades of government failure to hit the guerrillas' top leadership.

Then the group's leader, Manuel "Sureshot" Marulanda, died of natural causes.

"The only thing the FARC can negotiate at this point is its own defeat and they are not ideologically suited to do that," Jimenez, who is now a political analyst, said. "It would be an illusion to think the FARC is just going to collapse."

RESCUE REVEALS FISSURES

But it was the rescue, in which state agents posed as members of a FARC-friendly group promising to transport the hostages to a new location by helicopter, that exposed how disorganized the guerrilla army has become.

Once in the air the captives were told they were free, causing a celebration so raucous it almost downed the aircraft, said Betancourt, who was an international cause celebre and the FARC's main bargaining chip for a prisoner swap.

The group's top international ally, leftist President Hugo Chavez from neighboring Venezuela, has urged the intransigent rebels to free all hostages and start talks for peace.

But the rebels are well-funded by taxing the 600 tonnes of cocaine exported from Colombia each year even as Uribe's policies attract investment to the developed northern parts of the country. The rural southern regions may remain a risk.

Uribe, who has many supporters clamoring for him to change the constitution to run for a third term in 2010, wants to turn the south into a big food and biofuel producer. But those plans are only in first stages and depend on more security advances.

A decade ago, the rebels were taking over towns, encroaching on cities and blowing up energy installations so frequently that investors shunned Colombia.

But now the FARC appear increasingly like a group such as Shining Path, which used to attack in Peru at will but now is left with only isolated hold-out units.

"It is likely that the FARC will gradually fragment into smaller groups still engaged in cocaine and other crime," said Michael Shifter, of the Washington-based think tank Inter-American Dialogue.

"This will continue to be a problem for Colombian, but a far cry from the unified force the FARC was 10 years ago."