Blatter said Australians had every reason to feel aggrieved by the manner of their exit when they were beaten by eventual champions Italy 1-0 in the June 26 second round encounter.
"I agree with them and I would like to apologise (to) our fans in Australia," Blatter said.
"The Socceroos should have gone into the quarter-finals in place of Italy... because they were up to beating Italy."
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Australia looked to be in control of the match with Italy reduced to 10 men and extra-time looming when Spanish referee Luis Medina Cantalejo awarded the Europeans a hotly-disputed last-minute penalty that they converted for the win.
The Australian players and millions of fans were furious at the decision because of what appeared to be a blatant dive by Italy's Fabio Grosso when he was confronted by Socceroos defender Lucas Neill.
Australia were among a number of countries at the tournament who were victims of poor refereeing and cheating from players taking dives or feigning injury.
FIFA has been reluctant to speak out on the issue but Blatter, who has admitted he used to dive when he was a player himself, said it was clear there was a major problem with both referees and players.
"I think the referees were not at their best," he said.
"I think they were too well prepared or not looked after the right way. They were in a military camp situation...
"And I think there was too much cheating on the players' side."
Football Federation of Australia (FFA) chief executive John O'Neill's welcomed Blatter's belated apology but said it was of little real comfort.
"The position he's stated is what all of Australian football fans felt at the time," O'Neill told reporters.
"It's now four months after the tournament. It's a nice gesture, but it doesn't change the result."
Blatter also dismissed suggestions the 2010 World Cup could be moved from South Africa to another country, insisting the event will proceed as planned.
"They will be ready, no problems they will be ready," Blatter told Australian television network SBS on Sunday.
"The plan C and B in my opinion is still South Africa."
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