Protesters staged one of Vietnam's largest ever anti-China demonstrations Sunday, decrying Beijing's deployment of a deep-water drilling rig in contested waters as territorial tensions soar.

Some 1,000 people, from war veterans to students, waved banners saying "China don't steal our oil" and "Silence is cowardly" -- a dig at Hanoi's handling of the dispute -- and sang patriotic songs in a park opposite the Chinese Embassy.

"This is the largest anti-Chinese demonstration I have ever seen in Hanoi," said war veteran Dang Quang Thang, 74.

"Our patience has limits. We are here to express the will of the Vietnamese people to defend our territory at all costs. We are ready to die to protect our nation," he told AFP.

Hundreds of plain clothes and uniformed police set up barricades to prevent protesters approaching the Chinese Embassy compound but made no move to break up the rowdy demonstration, even though the communist regime normally tightly controls any public expression of discontent.

The two countries are locked in long-standing territorial disputes in the South China Sea over the Paracel and Spratly islands, which both claim, and often trade diplomatic barbs over oil exploration and fishing rights in the contested waters.

Tensions between the communist neighbours have risen sharply since China unilaterally announced in early May it would move a deep-water drilling rig into disputed waters -- a move the United States has described as "provocative".

Vietnam said China's decision was "illegal", demanded the rig be withdrawn, and dispatched vessels to the area -- which it claims were subsequently attacked and rammed by Chinese ships.

"I think that escalation is possible," analyst Nguyen Quang A told AFP.

- Message to Beijing -

Vietnam has alternated between tolerating anti-China rallies and violently breaking them up. The communist regime is wary of public gatherings that could threaten its authoritarian rule.

The leadership uses public protest as a means of expressing extreme discontent with Beijing, said Professor Jonathan London at City University of Hong Kong.

"Hanoi is well aware that permitting this kind of activity is a clear message to Beijing (and is also) keenly aware and anxious about maintaining social order," he said.

Faced with "widespread anger" among the Vietnamese population over China's actions, the government has had no option but to allow the protests to go ahead, London told AFP.

"Suppressing public protest against what has occurred would be regarded as absolutely illegitimate behaviour," he said.

Dozens of anti-China demonstrations have been held in Vietnam since 2007 to protest Beijing's perceived aggression over territory.

On Sunday it appeared there was a pro-government faction within the demonstration, including young protesters clad in t-shirts bearing Vietnam's revered founding president Ho Chi Minh's face, waving the communist hammer and sickle flag while shouting "Down with China!"

Other dissident-aligned factions at the protest were more critical of the Vietnamese government's handling of the dispute and used the opportunity to call for changes to the one-party state.

"We want to send a message to the Vietnamese government also -- they are responsible for this situation," demonstrator Tran Xuan Bach told AFP.

The standoff over the rig has already had economic ramifications for Vietnam, with the stock market plunging Thursday and import-export traders as far afield as the northern Lao Cai border crossing with China saying they were concerned about the effect of the dispute on business.

"There might be some immediate impact but this is a chance for Vietnamese to show their unity and patriotism. We just cannot only pay attention to our meals and clothes and neglect the nation," said protester Nguyen Dong Yen.

A large protest of around 1,000 people also took place Sunday outside the Chinese consulate in the southern business hub Ho Chi Minh City, and a smaller rally was reported in central Danang city.

Vietnam's tightly-controlled state media have covered the oil rig dispute closely and reported on the demonstrations Sunday. There was no official comment from the government.