* EU Justice Chief expresses dismay in letter to Zagreb
* Reding warns Croatia to change rules breaching EU law
* Measures could include cut to aid, monitoring
By John O'Donnell
BRUSSELS, Sept 5 (Reuters) - The European Commission has warned Croatia it may face legal action soon if it does not quickly change a law that clashes with EU extradition rules.
Last July, the small Adriatic state became the 28th member of the European Union, marking a recovery from years of war after Yugoslavia collapsed in the 1990s.
It quickly fell into disagreement with Brussels over amendments to its extradition laws, which effectively ensured protection of veterans from Croatia's 1991-95 independence war from facing inquiries elsewhere in the EU.
Following pressure from the EU, the Zagreb government pledged last month to apply European rules in full, in an effort to avoid sanctions which could include loss of EU aid.
But the EU's top justice official, Viviane Reding, warned Croatia in a letter to the country's Justice Minister Ornate Miljenic dated Sept. 4 that its promise to change how the European Arrest Warrant will be applied in Croatia next year was not enough.
"I am ... surprised to learn that the amendment would take more than 10 months and would only enter into force on 15 July 2014," Viviane Reding wrote in the two-page letter, seen by Reuters, referring to the planned change in the country's law.
"This step needs to be taken unconditionally and promptly," she wrote, adding that she intended to propose actions "in the coming days".
In addition to cutting funds, the European Commission could introduce a monitoring mechanism to check Croatia's efforts in complying with EU rules. Romania and Bulgaria, which joined the EU in 2007, face similar scrutiny over their progress in fighting corruption, and governments there view such measures as embarrassing and unnecessary.
EU governments could also use the dispute over the European Arrest Warrant as an excuse to delay discussions over bringing Croatia into Europe's passport-free Schengen travel zone, which Zagreb said was its next priority.
Croatia's opposition HDZ party, which ruled the country in the 1990s and between 2004-2011, has accused Zagreb's leftist-led government of tweaking EU rules to protect former Croatian intelligence chief Josip Perkovic.
The official had worked for communist Yugoslavia's secret service, the UDBA, and led intelligence services after Croatia became independent, and now faces charges in Germany over the 1983 murder of a Yugoslav dissident in Bavaria.
Prime Minister Zoran Milanovic has denied any connection with the German case and says Croatia only sought to exercise the same privileges as its EU peers.
EU members could request exemptions from the European Arrest Warrant before 2002, but the Commission says that only applies to states that were in the bloc at the time.
Croatia could have asked for exemptions when it was negotiating its entry to the European Union, but did not do so. (Reporting By John O'Donnell)