The French government has given the clearest public indication so far that it will insist on a special low-grade fuel for any nuclear reactor it builds in Iraq to replace the one destroyed by Israel last June.

Use of the fuel, called "caramel," would mean uranium for the Iraqi reactor could be kept to an enrichment level as low as 7 percent, well below widely recognized requirements for production of nuclear weapons yet sufficient to allow the reactor to serve as the research and training center Iraq and France say it is designed to be.

Israel cited fears that Iraq intended to make nuclear bombs as the reason for its June 7 raid on the French-built reactor at Tamuz, near Baghdad. Prime Minister Menachem Begin has mentioned the same fears in his warnings that any attempt to rebuild the reactor will bring on another Israeli bombing raid.

It is unclear whether Iraq will accept French conditions if Paris makes them part of a take-it-or-leave-it offer. According to reports in the French press, Iraqi officials have warned they will shop elsewhere, possibly in Italy, if they are unable to get the kind of reactor they want from Paris.

French officials said talks on rebuilding Tamuz have not come to a conclusion, and Iraq has not been forced to make a clear-cut decision on what type of controls it would accept.

In the meantime, French and Iraqi scientists are considering the possibility of a bomb-resistant cavern as the site for any new reactor, a knowledgeable source reported. The site, which has not yet been chosen, could be a natural cave or it could be carved into the side of a mountain deeply enough to offer protection against any new attack by Israeli planes, he said.

President Francois Mitterrand's government last fall announced a willingness in principle to rebuild the reactor despite Begin's warnings. At the same time, Mitterrand's ministers have been careful to add assurances that they will require increased safeguards against the possibility of using the reactor to build nuclear weaponry. Because of secrecy surrounding negotiations under way with President Saddam Hussein's government in Baghdad, however, the assurances have remained expressions of principle.

But in a written answer to a question on Tamuz in the French Senate last Friday, Foreign Minister Claude Cheysson made what French sources described today as a clear allusion to insistence on use of the caramel fuel.

"The French government intends to develop cooperation in the area of peaceful nuclear energy use with different countries--notably the Third World--that wish to do so, taking into account French interests as well as those of purchasing countries and in line with the orientation of our foreign policy such as it is defined, for export of nuclear material, in the Council on Foreign Nuclear Policy," he said.

"It is obvious that Franco-Iraqi cooperation will take into account the possibilities offered by the most recent engineering, including in the area of fuel, so as to assure that the use of this reactor is exclusively peaceful."

The council, which groups Mitterrand's key ministers along with government nuclear experts, held a secret meeting just before Christmas in what the sources said was an effort to define the Socialist government's policy on nuclear exports, including the Tamuz issue.

Although nothing has filtered out about what the council decided, Cheysson's declaration--the first such statement since the meeting--seemed to indicate that strong controls and the low-grade fuel will be part of any new deal with Iraq, said a source in the nuclear field.

French sources say another condition being discussed is an extension of the period during which French technicians would be present at any new reactor. This is almost as important as the type of fuel, they say, but it is not known whether Iraq would accept.

Tareq Aziz, Saddam Hussein's deputy prime minister, came to Paris within six weeks of the Tamuz bombing, winning the French pledge in principle to build a new reactor. From the beginning, however, French officials began talking about low-grade caramel fuel as a way to obviate fears in Israel and elsewhere that the reactor could open the way to Iraqi nuclear-weapons production.

The fuel takes the form of small brown squares resembling caramel candy--hence its nickname. A French development, it has been hailed as giving non-nuclear countries the possibility of nuclear research without raising fears of expanding the nuclear-weapons club.

The fuel can function only to a 10 percent enrichment level. French nuclear scientists say a 20 percent enrichment level is necessary for weapons production. Thus, although other means of producing weapons could be devised, use of caramel would rule out possible diversion of highly enriched uranium fuel from research reactors to bomb producton, they say.

The enrichment process consists of increasing the percentage of Uranium 235 in the fuel. The uranium at Tamuz was enriched to about 80 percent, although officials at the French Atomic Energy Commission insist it was not being diverted for weapons production and French technicians would have been present for a number of years to monitor its use by Iraq.

The Tamuz facility, called Osirak, did not use caramel fuel because the system had not been developed when France and Iraq contracted for the reactor in 1975. After development of caramel, French officials proposed switching to it but Iraq refused.