Air France and Dutch carrier KLM have agreed a multi-million dollar merger deal that will create the world’s third largest airline.

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Italian flag carrier Alitalia is to hold talks with Air France about joining the new group, potentially making it an even more powerful player in the beleaguered global airline industry.

The deal, which is worth more than $A1.3billion, is being financed with a complex share-swap that will see the creation of a holding company, Air France-KLM.

Passengers will see little difference because brands, hubs and flight networks of the two companies will be maintained.

Air France is to hold 81 percent of the group, to be led by Air France chairman Jean-Cyril Spinetta, with KLM owning the remaining 19 percent.

KLM, which has struggled to find a European partner for many years, saw sales and its share price drop substantially in the past two years owing to a worldwide slump in aviation, caused partly by the September 11 attacks.

The new Air France-KLM will rank first in the world in terms of sales and third in terms of traffic, just behind American Airlines and United Airlines.

There are fears the tie-up could cost jobs – particularly as it is seen as a reaction to the impact of so-called no-frills carriers – but no specific plans have yet been announced.

In Brussels, the European Commission said it would examine the arrangement for breaches of European Union competition law.

Last year, the French and Dutch carriers posted combined sales of 19.2 billion euros ($A32.9 billion), with a workforce of 106,000 operating a fleet of 540 planes serving 226 destinations.

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