Meanwhile, South Korean Unification Minister Jeong Se-hyun said Monday that such "further steps" could be taken if North Korea prepares for a missile launch or formally announces it has completed reprocessing 8,000 spent fuel rods — a move that could yield atomic bombs within months.
Jeong did not specify what "further steps" could be. During talks in Beijing last month, U.S. officials say North Korea claimed that it had finished reprocessing the rods.
The Council on Foreign Relations report declares that it is increasingly likely North Korea can and will move to produce additional nuclear weapons material.
It urges bilateral talks to reach a "verifiable nuclear settlement." The White House has rejected direct talks, instead pushing for international negotiations that would include South Korea, China and Japan.
If direct talks fail, the report says the U.S. should seek sanctions and consider imposing a blockade to intercept any nuclear exports from North Korea. U.S. allies in the region fear that would move Pyongyang closer to war. North Korea has said it would treat new sanctions as an act of war.
Nuclear tensions have gripped the Korean peninsula since October, when U.S. envoys claim North Korean diplomats told them they had launched a uranium enrichment program, which could create fuel for nuclear bombs.
On Monday, a South Korean delegation arrived in North Korea for talks to promote joint economic projects, but South Korea's prime minister warned the projects could be canceled if the North escalates tensions over its nuclear ambitions.
"We will continue to develop inter-Korean relations as long as the North Korean nuclear issue does not deteriorate," Prime Minister Goh Kun said. "(But)it is inevitable that inter-Korean exchanges and cooperation will be hurt if the North Korean nuclear issue deteriorates."
The two sides are expected to discuss building rail and road links across the heavily armed border, building an industrial complex in the North Korean city of Kaesong and resuming a joint tourism project to the North's Diamond Mountain. North Korea suspended the project last month, citing fears of SARS.
The issue of rice also came up.
South Korea will grant a North Korean request for free rice aid "only if the North promises not to worsen the situation over the nuclear issue," a Unification Ministry official said on condition of anonymity.
South Korea provided North Korea with 400,000 tons of rice last year.
The Council on Foreign Relations report recommends bolstering the alliance between the United States and South Korea, strained recently by disputes over the size and status of thousands of American troops stationed in the South. The report also urges a larger role for China.
It suggests a "comprehensive" settlement containing commitments by North Korea to end nuclear programs and allow inspections, and by the U.S. to end sanctions, establish normal diplomatic relations with Pyongyang, and refrain from military strikes if North Korea keeps up its end of the deal.
North Korea, which says it fears attack because of the new U.S. doctrine of preemptive war, has repeatedly asked for such a non-aggression pact. Washington says it has no intention of attacking, but has rejected the idea of a pact.
During a summit in Washington last Wednesday, President Bush and South Korean President Roh Moo-hyun agreed to seek a peaceful solution to the nuclear standoff with the North but also to consider "further steps" if Pyongyang increases threats to stability on the peninsula.