(Updates with background on litigation, comment from Citi, quote from court-appointed mediator)
By Nate Raymond and Daniel Bases
NEW YORK, Nov 10 (Reuters) - A U.S. judge ruled on Monday that Citigroup Inc could process an $85 million interest payment by Argentina on bonds issued under its local laws following its 2002 default.
U.S. District Judge Thomas Griesa in New York said Citigroup could process the Dec. 31 payment it receives on U.S. dollar-denominated Argentine law bonds.
The judge also called off a Dec. 9 hearing over whether the bank could regularly process payments Argentina makes on the bonds. Briefing will be deferred into 2015.
Griesa's order gives Citigroup further breathing room in a dispute between hedge funds suing over defaulted Argentine debt, known as holdout creditors, and the country, which defaulted in July.
Citigroup has said it faces regulatory and criminal sanctions by Argentina if it does not process interest payments on Argentina bonds issued under local law.
Danielle Apsilos-Romero, a Citigroup spokeswoman, confirmed that the order will allow processing of the $85 million payment.
A spokesman for Elliott Management's NML Capital Ltd, one of the holdouts, declined to comment. A spokeswoman for Argentina's economy ministry was not immediately available for comment.
Argentina defaulted in July after refusing to honor court orders to pay $1.33 billion plus interest to holdout bondholders when it paid holders of bonds swapped during the country's 2005 and 2010 debt restructurings.
The hedge funds, which also include Aurelius Capital Management, spurned Argentina's past restructurings, which resulted in exchanges on about 92 percent of the country's defaulted debt. Investors accepting the swaps were paid less than 30 cents on the dollar on average.
Griesa in July blocked Bank of New York Mellon Corp from processing a $539 million interest payment on what the country says is more than $28 billion in restructured debt.
Monday's order marked the third time Griesa had this year allowed Citigroup's branch in Argentina to process a payment to bondholders.
Daniel Pollack, the court-appointed mediator in the case, told Reuters he thought Griesa was "giving the parties every opportunity to settle this long-running dispute."
"It is my hope that the parties will return to the bargaining table promptly after January 1," Pollack added. (Reporting by Nate Raymond and Daniel Bases in New York; additional reporting by Hugh Bronstein in Buenos Aires; editing by Andrew Hay)