CAIRO, JUNE 28 -- The Reagan administration has agreed to allow Egypt to produce the United States' top-of-the-line main battle tank, the M1A1 Abrams, in a move that will transfer sensitive technology to this Middle Eastern capital and support Egypt's bid to become the dominant arms merchant in the Arab world.

The decision, which has not been formally transmitted to Congress, is certain to draw fire from critics opposed to sending sensitive U.S. weapons technology abroad and from those who would consider Egyptian production of the Abrams to be a potential threat to Israel's security.

Powerful Defense Minister Abdul-Halim Abu Ghazala has lobbied Washington for more than a year to get approval for the M1 -- the shorthand name used for the tank during the prototype phase of development -- and has overcome U.S. Army opposition in Defense Department deliberations.

Abu Ghazala is said to have the support of President Hosni Mubarak, the Egyptian Cabinet and the ruling political party to designate the Abrams project as a national priority, a step considered essential to the program since the cost of M1 production may well soak up most of Egypt's $1.3 billion-a-year military aid allotment from the United States.

Abu Ghazala has said in several recent statements to the government-controlled news media that the Egyptian armed forces will produce as many as 1,000 to 1,500 M1s at a giant new factory under construction in the Nile Delta region north of Cairo.

American officials, here and in Washington, have not commented publicly on an M1 project for Egypt. A House Foreign Affairs Committee staffer said that "we have been asking" where the administration stands on transferring M1 production technology abroad. "The answer has always been that it is under review," he said.

But sources here said last week that the decision has been made and conveyed to Egyptian leaders in a series of private meetings between Abu Ghazala and Secretary of Defense Caspar W. Weinberger and his assistant secretary for international security affairs, Richard L. Armitage, who was here for his latest round of discussions on the M1 in late April.

"A decision has been made at the highest level to go ahead with production of the M1 tank in Egypt," one U.S. official said.

According to sources here, Weinberger already has approved an exception to the U.S. "national disclosure policy" for M1 technology transfer, and U.S. and Egyptian officials are working out the terms of a memorandum of understanding that will require Egypt to protect the M1's classified systems and the sophisticated metallurgical processes that give it the strongest coat of armor in the U.S. tank arsenal.

The Pentagon has earmarked $168 million in start-up funds for Egypt's M1 program beginning in the fall of 1988, according to sources.

U.S. Ambassador Frank G. Wisner, said by sources to be a strong supporter of the M1 production here, has told western officials that the importance of the program is that it represents another bond in the relationship between the two countries.

In addition, as the U.S. stake in the security of the Persian Gulf grows, Egypt is seen as a critical support base in the region.

More than a dozen American-made M1s from the U.S. Army's 24th Division will participate in this summer's "Bright Star" military exercise involving U.S. and Egyptian forces, according to sources.

Yet a number of obstacles remain to the M1 deal. Sources here and in Washington say questions have been raised about the proposed transfer of M1 technology to Egypt and the economic impact on Egypt's heavily burdened economy.

"It's a very dumb idea," said one American military expert in Cairo. "Economically, tank production is a very, very expensive proposition. Everybody has told the field marshal {Abu Ghazala} how dumb it is, and I think he recognizes the problem, but he has a vision of starting very slowly. He sees satellite industries springing up, but mostly he sees national pride.

"If you produce a good tank," this official continued, "it puts you in the category of a military power, and they {the Egyptians} very much want to be in that category."

Other critics of the proposed transfer say the loss of such a big order of tanks from U.S. factories will have a significant impact on American jobs.

Said one western military expert, "The issue is going to be that it is just as easy to produce those tanks in Detroit or Lima, Ohio," where M1 production plants of General Dynamics Corp. are located.

In addition, despite the peace treaty between Egypt and Israel, some officials are concerned that Israel's supporters in Congress may oppose giving Egypt, and perhaps other Arab states, the technology to build a tank that U.S. officials say can outshoot the Israeli main battle tank, the Merkava.

"The Israelis have not been heard from yet," one western official said.

The M1 is propelled by a high-speed turbine and packed with the latest onboard computers, electronic deception gear and laser sighting technology, intended to give it one of the most sophisticated capabilities to outshoot enemy tanks while racing at speeds of up to 70 mph.

The tank also has been plagued by criticism that it is too expensive to operate, requires frequent engine and tread changes and travels with overly elaborate maintenance and support systems.

The M1 production agreement comes at a time when Egypt is trying to revitalize plans made more than a decade ago to build an Arab world arms industry here financed by the oil-rich states of the Persian Gulf and by other regional powers such as Turkey and Pakistan. Those plans were shelved when Egypt made a separate peace with Israel in 1979, causing the gulf states to break relations and withdraw funding from Egypt.

The Egyptians, according to sources here, want the M1 to meet the military threat of Libya's Soviet-equipped Army in the next decade, but also as a matter of national prestige. U.S. officials see Egypt as a buffer against Libya and Marxist Ethiopia and a strong neighbor to vulnerable nations such as Sudan and Chad. As it is, the outdated Soviet and American tanks in Egypt's arsenal would be no match for the advanced Soviet models that Libyan leader Moammar Gadhafi is adding to his armed forces.

Egypt's military leaders also want an M1 production line to foster new feeder defense industries here.

Some officials say they believe that M1 production would overwhelm Egypt's capacity to absorb highly sophisticated industrial technology.

"The lack of quality control here is widely known -- it's horrendous," said one U.S. expert, adding, "I've been to every factory in Egypt that produces anything military, and the people who are quality control experts in the states would die from heart failure if they went to most of those places."

"There is a quality control problem," responded Maj. Gen. Gamal Sayyed Ibrahim, Egypt's minister of state for war production. "But quality control is not a problem because Egypt does not have technology. It is the training and what is inside you -- it's the discipline of education and the development of one's self."

Other western officials say Egypt's industrial sector is capable of significant quality control. These officials point out that for a number of years Egyptian aircraft assembly lines, optics houses and electronics factories have been turning out high-technology products that meet the specifications of U.S. and European manufacturers.

Egypt also has built an impressive record of refurbishing aging Soviet equipment in its arsenal and of engineering new hybrid weapons systems, such as an assortment of missiles and antiaircraft guns.

Some experts, however, fear the M1 program will crowd out funding for important new weapons purchases in the U.S. military assistance program to Egypt, but the Egyptians say an M1 production line would save the hard currency that they would have to pay to buy the Abrams off the shelf from General Dynamics.

Egypt is financing virtually all of its defense forces modernization through the U.S. military aid program. Military assistance to Israel and Egypt makes up the largest portion of the U.S. foreign military assistance program.

U.S. officials have estimated that it will take $15 billion to $20 billion to modernize the Egyptian military, which was armed and equipped by the Soviet Union during the 1960s and early 1970s.

Egypt is using U.S. military aid to buy F16 jet fighters from General Dynamics and soon will have taken delivery of half of the 160 fighters it has set out to purchase to give its Air Force a modern intercept capability. The price tag for the remaining F16s will exceed $2.5 billion, sources said.

The country's air defense command is purchasing improved Hawk antiaircraft missiles from Raytheon Co. and has begun a joint venture production of air defense radars with Westinghouse.

U.S. Army officials, according to several sources, opposed the M1 transfer, arguing that Egypt might end up spending twice as much to produce each tank as it would cost to buy M1s directly from General Dynamics.

"The {U.S.} Army has said it is not a good idea," said one western official here, "but {the} Defense {Department} is for it."

Each M1 costs the U.S. Army about $2 million, but the export price to Egypt would be about $3 million per tank under the foreign military sales program, in which Egypt buys with credits that do not have to be repaid. Some U.S. Army officials predict that Egypt will spend $4 million a copy to build each Egyptian M1, especially after it invests in all of the facilities needed to produce it.

"My impression from the Egyptians is that they do not give a damn about cost," said one western diplomat. "It's more important that they get the technology to become a first class industrial power that can produce a main battle tank."

Other officials have pointed out that Egypt will be hard pressed to reduce the cost of M1 production by finding other Middle Eastern customers for the tank because U.S. permission will be required for any resale. Egypt's biggest current customer for weapons is Iraq, which has been at war with Iran for seven years.

The United States has taken an official position of neutrality in the war, and western sources say U.S. officials already have turned down Egyptian requests to sell the M1 to Iraq after the production line is established.

"The Egyptians have not been very successful at exporting, except to Iraq," said one western official.

Abu Ghazala already has been out stumping the Middle East in hopes of drumming up buyers for an Egyptian M1. On a recent trip to Turkey, a member of the North Atlantic Treaty Organization, Abu Ghazala proposed cutting Ankara in on the M1 deal, saying that by producing 1,500 tanks for both armies, an Egyptian-Turkish joint venture could cut the M1's cost 30 to 40 percent.

U.S. and Egyptian officials are debating how quickly Egypt can tool up to produce the M1. For instance, the country's large industrial sector does not have the capability to produce the giant steel-alloy ingot from which the barrel of the M1's 120mm gun must be fabricated with precision machine tools.

The U.S. Office of Military Cooperation here, headed by Maj. Gen. Robert D. Wiegand, has proposed a six-phase program in which the Egyptians would develop in two-year increments the various industrial capabilities to produce the M1, including initial coassembly with General Dynamics.

The Egyptians have complained that under the American approach it will take 10 years or more to complete the production line tranfer. They have argued for an accelerated program, which American officials reportedly are willing to modify.

One western official said he was concerned that because of the high profile of the M1 project, it is certain to attract a sufficient number of critics to draw out the transfer process in a way that adds irritation to U.S.-Egyptian relations.

"Every time a hitch develops, the Egyptians are going to blame us," the official said.