(Adds Citigroup statement and planned appeal)
By Jonathan Stempel
NEW YORK, March 12 (Reuters) - A federal judge on Thursday said Citigroup Inc cannot process interest payments by Argentina on some bonds issued under that country's law, a defeat for the cash-strapped nation as it attempts to re-enter international debt markets.
U.S. District Judge Thomas Griesa in Manhattan said letting Citigroup process the payments on so-called dollar-denominated exchange bonds would violate a requirement that Argentina treat bondholders equally.
Griesa's decision upheld his order on July 28 that blocked Citigroup from making the payments on an estimated $2.3 billion of bonds.
"This is a major blow," said Ignacio Labaqui, an analyst for Medley Global Advisors in New York.
Citigroup asked Griesa on Thursday night not to enforce his decision while it appeals, warning of "catastrophic consequences" for its Citibank unit if it fails to process a $3.7 million payment scheduled for March 31.
Karen Wagner, a lawyer for Citigroup, said in a court filing that failure would result in "immediate and irreparable injury" to the bank, "including the possible loss of its valuable Argentine banking license."
Argentina's economy ministry declined immediate comment.
Jonathan Blackman, a New York lawyer representing Argentina, said the country is disappointed and will pursue its own appellate remedies.
Griesa's decision is the latest setback for Argentina in a long-running battle stemming from the country's roughly $100 billion sovereign debt default in 2001.
Argentina subsequently restructured its bonds in 2005 and 2010, swapping existing bonds for new bonds worth less than one-third as much.
But a group of bondholders known as "holdouts," including billionaire Paul Singer's Elliott Management LP hedge fund and its NML Capital affiliate, as well as the Aurelius Capital Management hedge fund, refused to accept the terms, and demanded to be paid in full.
Argentine's dollar-denominated bonds gave up early gains after the decision, and were down by roughly 1 percent to 4 percent in late trading, Reuters data show.
Griesa has ruled that the holdouts must be paid before Argentina makes payments on the restructured bonds.
Argentina refused, and defaulted last July after rejecting Griesa's order that it pay $1.33 billion plus interest to the holdouts.
Citigroup has portrayed itself as being in a legal no man's land, forced to choose between processing payments in defiance of Griesa's order, or not processing payments and putting its ability to do business in Argentina at risk.
Griesa acknowledged the predicament, saying "neither option is appealing," but said it was the result of Argentina's having "refused to observe the judgments of the court to whose jurisdiction it acceded."
An NML spokesman said the decision shows that "any" third party," not just Citigroup, is forbidden from helping Argentina circumvent Griesa's injunction by processing payments.
"Argentina should discontinue its defiance of courts and negotiate a resolution to this dispute," the spokesman said.
An Aurelius spokesman declined to comment.
Griesa said "the vast majority" of exchange bonds governed by Argentine law qualified as "external" indebtedness, triggering the equal treatment requirement. Last year he allowed the processing of three payments on the bonds.
The judge again urged that Argentina work with court-appointed mediator Daniel Pollack to end its disputes with the holdouts. Pollack declined immediate comment.
Blackman, the Argentina lawyer, said the result of Griesa's decision is to expand injunctions that have "made it more difficult to reach a resolution."
Argentine President Cristina Fernandez has long criticized the holdouts as "vultures."
She is barred from seeking a third term, and the leading candidates to succeed her in December may choose a more conciliatory approach.
"There is a lot of hope that economic policy will change, but that's going to be a long-term process," said Roberto Drimer, an analyst at Buenos Aires-based consultancy VatNet.
David Rees, emerging markets economist at Capital Economics Ltd in London, this month said processing the payments could have enabled Argentina to resume servicing some debt, and perhaps issue new dollar-denominated debt outside the United States.
Argentina tried in February to sell $2 billion of dollar-denominated bonds through Deutsche Bank AG and JPMorgan Chase & Co.
It scrapped that plan after Griesa demanded that the banks turn over documents related to the proposed sale, which had been the subject of a subpoena.
The case is NML Capital Ltd v. Argentina, U.S. District Court, Southern District of New York, No. 08-06978. (Reporting by Jonathan Stempel in New York; Additional reporting by Hugh Bronstein, David Ingram, Richard Lough, Sarah Marsh, Hernan Nessi and Davide Scigliuzzo; Editing by Bernadette Baum, Richard Chang and Diane Craft)