The security firm Blackwater USA today resumed limited escorts of American personnel in the Iraqi capital after an incident in which eight civilians died, the US embassy in Iraq said.

As Blackwater guards returned to the streets of Baghdad after a three-day suspension, the Iraqi interior ministry said it planned to end immunity from prosecution for security contractors.

The interior ministry spokesman Major General Abdul-Kareem Khalaf said the ministry had drafted legislation giving it tighter control over contractors and calling for "severe punishment for those who fail to adhere to the ... guidelines".

Iraq has said it will review the status of all security firms after what it called a flagrant assault by Blackwater contractors in which at least eight people were killed while the firm was escorting a US embassy convoy through Baghdad on Sunday.

The US and Iraq are planning a joint inquiry amid conflicting accounts of what happened. Blackwater said its staff acted "lawfully and appropriately" after coming under attack. But the Iraqi government insisted Blackwater had opened fire on innocent civilians.

The deaths have created fresh tensions between the US and Iraq. The Iraqi prime minister, Nuri al-Maliki, suggested the US embassy should stop using Blackwater and said he would not allow Iraqis to be killed "in cold blood".

The US embassy spokeswoman Mirembe Nantongo said the decision to allow Blackwater to guard some "mission essential" trips was made after talking to Iraqi authorities.

"There isn't a lot of movement in general ... But it is likely Blackwater will support some of them," she told the Reuters news agency.

The killings angered Iraqis, who regard the tens of thousands of security contractors working in the country as mercenaries operating with little regard for Iraqis.

Mr Khalaf said the new draft law, which he expected parliament to pass soon, gave the ministry powers to prosecute the companies and to refuse or revoke contracts.

Many security firms operating in Iraq have no valid licence and a law issued by US administrators after the 2003 invasion, which granted them immunity from prosecution, has not been formally revoked.

The New York Times reported on Friday that the interior ministry would also propose that foreign security companies be replaced by Iraqi firms.

"These American companies were established in a time when there was no authority or constitution," the newspaper quoted a ministry report as saying.

The head of an association of security firms in Iraq said replacing foreign companies with Iraqi ones was not a new suggestion, but was unlikely to happen overnight.

"One alternative would be partnerships with Iraqi companies, putting an Iraqi face on what we're doing," Lawrence Peter, the director of the Private Security Company Association of Iraq, told Reuters.

Blackwater is the biggest of three private security firms employed by the US state department in Iraq. Private security staff who are involved in controversial incidents are often hastily withdrawn, but those involved in the Sunday shootings were still in Iraq.