The inquiry was told an aide-memoire to Lord Trefgarne, the former Minister of Defence Procurement, from Alan Barrett, a senior MoD official, revealed Lady Thatcher approved exports by Coventry-based Matrix Churchill.
Mr Barrett, an official in the Defence Export Services Secretariat, said the then Prime Minister agreed not to revoke licences granted to protect an intelligence source.
It was the collapse of the Matrix Churchill trial last year which led to the setting up of the Scott inquiry by John Major.
Three executives were acquitted of breaching export regulations after evidence emerged that ministers knew of the company's activities. Two executives, including Paul Henderson, the former chief executive, who was acquitted at the Old Bailey, had been working for MI5 and MI6.
Mr Henderson said last night it was 'disgraceful' the document had not been disclosed to his defence lawyers. 'That document clearly involves an approval from the Prime Minister relating to the issue of the licences therefore it should have been given to us in court.'
It was written in December 1988 prior to a meeting between Lord Trefgarne and Trade and Foreign Office counterparts which led to government guidelines limiting defence exports to Iraq being relaxed.
Mr Barrett said export licences had been granted to Matrix Churchill in a deal worth pounds 16.5m. Some had been exported before their real use was discovered.
The remaining shipment was halted while the MoD tried unsuccessfully to find 'collateral' evidence for the information so as not to jeopardise the original intelligence source. 'The Prime Minister agreed that in order to protect the intelligence source the licences already granted should not be revoked,' he wrote. Since then fresh intelligence had emerged suggesting a 'more disturbing use' had been discovered for the lathes - believed to be Iraq's nascent nuclear weapons project.
'This case needs to go back to the Prime Minister before we could recommend approving the current applications,' he wrote. He suggested Lord Trefgarne press for a separate submission to the Prime Minister 'as she was involved last time'.
The document's existence was revealed during questioning of Mr Barrett's superior, Ian McDonald, head of the DESS. Mr McDonald said he read the five-page document at the time but failed to notice the reference to Lady Thatcher. He had not been told of any involvement by her and found it 'puzzling'.
Mr Barrett was a member of the Restricted Enforcement Unit - a Whitehall committee that included MI6, MI5 and customs representatives who swapped intelligence about export regulation breaches. It was so sensitive it would meet only in rooms swept for bugging devices.
It is understood the Scott inquiry team has not uncovered other documents implicating Lady Thatcher.
Mr Barrett has yet to reply to a questionnaire sent by the team. Once he has, he will be invited to give evidence publicly.Reuse content