South Korea has suspended a $1.61 billion deal to upgrade its fleet of F-16 fighter jets because of delayed work and cost over-runs, a government agency said Thursday.

The US unit of London-based BAE Systems had been chosen over US aerospace giant Lockheed Martin for the 1.75 trillion won project to upgrade the South Korean air force's fleet of 134 F-16s.

The upgrade began in December last year through a foreign military sales programme covered by guarantees from the US government, as the F-16 is a Lockheed product.

But it was suspended in recent days because of faltering negotiations over additional costs presented by both BAE Systems and the US government, Seoul's Defence Acquisition Programme Administration (DAPA) said.

BAE Systems has demanded 300 billion won in additional expenses, and the US government in turn wants Seoul to cover an extra cost of 500 billion won because of the increased risk of the project falling through, it said.

South Korea insists it will not agree to price hikes that run far beyond the original agreement.

"BAE Systems' work has been suspended temporarily following discussions between the US and South Korean governments," DAPA spokesman Kim Si-Cheol told reporters.

He warned Seoul could cancel the contract and seek a new partner "unless our demands are met".

But Kim stressed: "There has been no decision to cancel it (already). Negotiations are still under way between the two sides."

Yonhap news agency said Seoul would open alternative talks with Lockheed, one of its long-term partners in military procurement.

"But our best-case scenario is that (Seoul) keeps its original deal with BAE Systems," a military source was quoted as saying.

South Korea is in separate talks with Lockheed on terms of a 7.3 trillion won deal to buy 40 next-generation F-35A jets.