* Netherlands eyes cutting planned order of 85 jets
* Sources say order may drop by 17 to 33 jets
* Rising costs, budget cuts may limit orders
By Sara Webb and Andrea Shalal-Esa
AMSTERDAM/WASHINGTON, March 21 (Reuters) - Dutch orders for the Pentagon's F-35 warplane are likely to be cut back, sources close to the discussions told Reuters, citing cost overruns and delays in the program, uncertainty over the Netherlands' defense strategy and budget cuts across Europe.
The Netherlands may cut 17 to 33 F-35s from its initial plans to buy 85 of the new warplanes, according to people close to the discussions who were not authorized to speak publicly since final decisions are not expected until later this year.
U.S. officials fear cuts in orders by the Dutch or other buyers could trigger a "death spiral" in the Pentagon's biggest arms program by driving up the price of remaining orders, leading to more cancellations. Washington alone has already delayed 410 of its 2,443 orders beyond 2017.
Built by Lockheed Martin Corp, the F-35 Joint Strike Fighter is designed to be the next-generation fighter jet for decades to come for the U.S. Air Force, Navy and Marines, as well as U.S. allies in Asia and Europe.
But the $400 billion weapons project, which is developing a replacement for the F-16 fighter jet and nearly a dozen other warplanes in use, has been hit by technical faults, is seven years behind schedule and 70 percent above early cost estimates.
The Netherlands is one of several allies, along with Britain and Italy, that are deeply invested in the program. So far it has spent a total of 1.233 billion euros ($1.59 billion) on its involvement, the General Auditor reported in October.
However, continued Dutch participation in the project and the size of future orders are under increasing scrutiny as the euro zone's fifth biggest economy has been forced to come up with billions of euros in government spending cuts, while the two parties in the ruling coalition are at odds over the F-35.
Prime Minister Mark Rutte's Liberal Party, re-elected in September, has always been in favour of the F-35, but his new coalition partner, Labour, called in July for ending Dutch participation in the project. The plane's rivals are lobbying hard for cancellation, according to Dutch media reports.
The Netherlands was slated to buy 85 F-35 A-models to replace its F-16 fighter jets. But the former defense minister last year said the government would buy as few as 56 F-35s because costs had risen and only 68 F-16s needed to be replaced.
The new coalition, sworn into office in November, expects to finalize a new defense policy and F-35 purchase plans this year.
"The question is ... do we want to be able to do the same kinds of missions as in Kosovo, Iraq, and Afghanistan," said Marcel de Haas, a defense analyst and retired officer. "If we quit the F-35, it will cost us more than we have already paid and will cost us jobs. But the F-16 needs to be replaced - and soon."
A defense source close to the talks said there was no chance of the Netherlands ordering as many as 85 F-35s. "This number is completely out of date," the source said, adding discussions were focused on a procurement target of 52 to 68 planes.
With a budget of about 4.5 billion euros ($5.82 billion) to replace the F-16s, the Netherlands can only afford 33 to 35 F-35s, the source said, citing estimates from the General Auditor's office, which checks the government spends public funds as intended.
Withdrawing from the program and buying F-35s off the shelf would further raise the cost, the General Auditor's office said.
Defense analysts say an order that small would not allow the Dutch military to do the kind of missions it has in the past.
"Given the F-35's high price tag, large block orders are unlikely," said Richard Aboulafia, analyst at Teal Group Corp.
The average price per fighter has almost doubled from $69 million to as much as $137 million since the F-35 program began in 2001, according to a U.S. congressional watchdog agency. The Pentagon's F-35 program chief insists the plane's price will have dropped to around $90 million by 2018.
Lockheed officials visited Dutch officials earlier this year to reassure them about progress on technical challenges, efforts to lower production costs and flight testing, despite two engine-related groundings of the new stealth fighter in 2013.
Dutch defense ministry officials also met political party representatives last week to run through the various problems.
"Politicians are worried, but not overly worried," about the cost overruns, delays and technical problems, the source said.
Senior Dutch officials participated in a regular twice-yearly all-day meeting of the United States and all the partners helping fund the F-35's development in Washington on Wednesday.
U.S. defense sources said the meeting included discussions about the start of operational testing of the new jet, an issue of concern to the Netherlands, which has ordered two planes with extensive sensors and wiring to participate in test flights.
U.S. defense officials say the Netherlands remains active in the program and has not reduced its projected orders.
Some Dutch politicians question whether the country needs such an expensive fighter, or whether to go for an alternative such as Saab AB's Gripen, Boeing Co's F/A-18 E/F Super Hornet, or the EADS Eurofighter.
Lockheed officials insist the plane's production costs are coming down and say none of those other airplanes would give the Netherlands the same fifth-generation capabilities of the F-35.
"The Dutch have to make up their minds about what they want their military's role to be. If they want to participate in coalitions in the future, they'll stick with the F-35," said one source familiar with the F-35 program.