91Èȱ¬

The French press is sniffing cautiously but persistently around a story that some believe has potential to do enormous damage to President Nicolas Sarkozy.

It is a complex tale linking arms sales to Pakistan with the secret funding of French politics. A 2002 bomb attack that killed 11 French naval engineers in Karachi also plays a part.

The president and his advisors have dismissed any suggestion of wrong-doing on his part as "grotesque".

However, there have been continuing suggestions that Mr Sarkozy may know more than he lets on.

The origins of the affair lie in the years 1993 to 1995, when Nicolas Sarkozy was budget minister in the government of conservative Prime Minister Edouard Balladur.

In 1994, France negotiated a deal to sell three Agosta-class submarines to Pakistan for a sum equivalent to 826m euros (£684m, $996m).

In accordance with standard procedure back then (only in 2000 did France sign an OECD convention outlawing commissions), some 50m euros were paid as "sweeteners" to various senior Pakistani figures.

So much is uncontested (and perfectly legal). However, it is also alleged that a second tranche of commissions was also paid to two Lebanese intermediaries.

According to Le Contrat (The Contract), a new book by two French investigative journalists, this second tranche - amounting to 33m euros - was never intended to help secure the submarine contract, which was in any case almost concluded.

Instead, the money was to come back to France in the form of so-called "retro-commissions" in order to finance Mr Balladur's 1995 presidential campaign.

Though illegal, resorting to "retro-commissions" used to be common practice in the seamy underworld of French political funding.

When a major arms or oil contract was negotiated with a foreign country, the commissions would be inflated and part of the money returned secretly to France.

In this case, it is alleged that the money passed through a complex web of off-shore bank accounts, one of them in the name of a company called Heine in Luxembourg.

This is where President Sarkozy's name has been drawn in.

Investigators in France have already said that in 2007 they found an internal document from the French Naval Construction Directorate (DCN), stating that as budget minister, Nicolas Sarkozy gave his approval for the creation of Heine.

And this week a report from the Luxembourg police revealed on the news website Mediapart makes the same allegation.

It says "agreement to set up Heine… appeared to come directly from Prime Minister Edouard Balladur and Finance (sic) Minister Nicolas Sarkozy."

The picture created by the allegations is this:

In 1994, Edouard Balladur was planning to run against Jacques Chirac as the main Gaullist candidate in the following year's election, but he was desperately short of funds.

So he allegedly intervened in the Pakistani submarine contract to ensure "retro-commissions" to finance his campaign, and used his loyal ally Nicolas Sarkozy to help set up the arrangements.

The French newspaper Liberation recently reported that in April 1995, Mr Balladur's campaign team lodged 10m francs in cash at the campaign's bank account.

Half of the money was in 500 franc notes, it said.

If the claims of secret funding through "retro-commissions" were true, then both Mr Balladur and Mr Sarkozy would have broken the law - with imponderable implications for the president's future.

However, both men dismiss the allegations as preposterous, defying their accusers to produce hard evidence.

Mr Sarkozy's close aide Claude Gueant said the claims that he had approved the creation of Heine could not be true, because the rules did not require the budget minister to have any say in the matter.

He also pointed out - correctly - the lack of detail in the leaked section of the Luxembourg police document.

"It has none of the rigour of a proper police report. It is all supposition, imaginary construction," he said.

The story so far is one of alleged corruption, but there is another twist to the tale - and a bloody one.

In 1995, Jacques Chirac defeated Mr Balladur in the first round of the vote and went on to become president.

According to Le Contrat, he immediately cancelled payment of the commissions which he knew (from intelligence sources) had helped to fund his rival's campaign.

Seven years later, an explosion killed 11 employees of the DCN as they travelled to work in Karachi.

For a long time it was presumed the attack was the work of al-Qaeda. But last year a new judge in charge of the case, Marc Trevidic, focused on another theory.

He believes that the Karachi attack may have been carried out on orders from unnamed Pakistani intelligence and military chiefs, angry that their share of the Agosta backhanders was never paid.

It is a monumental - and unproven - allegation. But the families of many of those who died are increasingly inclined to believe it.

Their lawyer, Olivier Morice, is the most outspoken of the president's critics.

"Nicolas Sarkozy was at the heart of the corruption and he has lied to the families. What we have before us is not some imaginary tale, but a state lie. The families are indignant and demand his resignation," he said.