The State Department told Israel yesterday that the United States will not renew a five-year agreement, which expired over the weekend, that allowed Israel to buy flawed diamonds at a negotiated price from the U.S. strategic stockpile.

"We told Israel the agreement would not be extended because it gave Israel a clear preference over domestic and other foreign buyers," a State Department spokesman said. The administration also concluded that the agreement was in conflict with the intent of the Stockpile Revision Act of 1979, under which Congress requires the use of competitive bids to buy from the stockpile, he added.

The decision not to renew the agreement was viewed by Israel as a policy tilt against it. Israel negotiated the agreement in 1975 with then-secretary of state Henry A. Kissinger and treasury secretary William E. Simon.

"There is a policy behind this which is reflective of a tilt," said Bert Davis of Patton, Boggs and Blow, the Washington law firm that has acted as Israel's attorney in the negotiations with the State Department. "The White House is very anti-Begin, which they're taking out on Israel," he said, referring to Israeli Prime Minister Menachem Begin.

In the five years the agreement was in force, Israel twice bought industrial diamonds at negotiated prices from the U.S. stockpile. The second time was in 1976, when it paid $9 million for industrial diamonds that domestic diamond merchants complained were worth more than that.

At the same time, diamond merchants in Belgium complained that Israel sold stockpile diamonds it did not want to a dealer in Antwerp, a deal that netted Israel a profit. Israel denied this complaint, pointing out that it sold off diamonds for tool-cutting that it could not use in the jewelry business.

Israel's prime interest in the flawed diamonds in the U.S. stockpile is to support its thriving diamond industry, which employs 20,000 artisans to cut and polish small diamonds. Last year Israel netted $1.5 billion from its worldwide diamond sales.

Mostly, Israel takes the best of the flawed diamonds from the U.S. stockpile and cuts them into stones smaller than one carat. Called "melees," stones this small are usually placed in clusters around larger gems in rings, brooches and pins.

Israel says it needs access to the U.S. stockpile because the only other source is the South African Diamond cartel, which in 1977 put a 40 percent surcharge on sales to Israel and cut back its allocation. Sources close to Israel's diamond dealers say the cartel took the action because Israel's diamond trade was taking business away from the cartel.

In deciding not to renew the five-year agreement, the State Department said it did not feel it was "tilting" against Israel, since Israeli diamond merchants can still enter competitive bids for flawed diamonds in the U.S. stockpile. There are to be five such sales in the next nine months, each involving the sale of 500,000 carats.

What bothered Israel the most is not so much the decision against renewal of the agreement but the "silent" decision earlier this year not to allow it access to the diamond stockpile while the agreement was still in force.

Israel had asked to buy up to $60 million worth of diamonds, but was turned down pending renewal of the agreement.

"The State Department was legally obligated to provide Israel with diamonds out of the excess stockpile, and they didn't do it," attorney Davis said. "This was totally inexecusable, and in my opinion as a lawyer was illegal."