Documents show British ministers knew at the time that the £14m plant, called Falluja 2, was likely to be used for mustard and nerve gas production.
Senior officials recorded in writing that Saddam Hussein was actively gassing his opponents and that there was a "strong possibility" that the chlorine plant was intended by the Iraqis to make mustard gas. At the time, Saddam was known to be gassing Iranian troops in their thousands in the Iran-Iraq war.
But ministers in the then Thatcher government none the less secretly gave financial backing to the British company involved, Uhde Ltd, through insurance guarantees.
Paul Channon, then trade minister, concealed the existence of the chlorine plant contract from the US administration, which was pressing for controls on such exports.
He also instructed the export credit guarantee department (ECGD) to keep details of the deal secret from the public.