Baghdad said on Wednesday it will close down state-owned Iraqi Airways in the face of a decades-old financial dispute with Kuwait that prompted the seizure of an aircraft last month.

The sudden move comes a day after the airline announced it was dropping its services to Sweden and Britain over the row with Kuwait, but it was not immediately clear if a new company would be formed to take its place.

"The cabinet decided yesterday (Tuesday) to wind up the Iraqi company," transport ministry spokesman Aqeel Kawthar told AFP.

"The decision was taken because of the numerous acts of harassment that the company has faced from Kuwait that have prevented its planes from taking on fuel and food at various airports," Kawthar said.

"The transport ministry will carry out the decision by the council of ministers, even though we disagree with it," he added, without giving details on whether a new company would be formed.

An aide to Prime Minister Nuri al-Maliki who attended the meeting at which the decision was taken confirmed the dissolution of the airline, speaking on condition of anonymity.

Kuwait Airways says Iraqi Airways owes it 1.2 billion dollars, a dispute dating back to Saddam Hussein's 1990 invasion of the neighbouring emirate. Kuwait says 10 of its planes as well as aircraft parts were plundered after its airport was seized during the invasion.

Kuwait said it will continue to pursue the debt, whether Iraqi Airways is closed or not.

"We will not concede our debt ... whether it is dissolved or not. If it is closed, we will pursue Iraqi officials responsible for the action," communications minister and government spokesman Mohammad al-Baseeri told a news conference.

"We will continue to press with our demands and legal and judicial measures to secure our rights approved by international courts," said Baseeri, whose ministry oversees Kuwait Airways.

For his part, US Ambassador Christopher Hill told reporters in Baghdad that Washington was concerned that the Kuwait-Iraq "relationship needs to get better".

He cautioned, however, that a thawing of ties was unlikely before the formation of a new government in Baghdad. More than two months after elections, no political bloc has yet assembled a parliamentary majority.

"I think it would be helpful in terms of the Kuwait relationship if Iraq got a government formed ... These are tough issues that require broad consultation within the Iraqi political system and the time to do that is soon after a new election."

He added: "Kuwait and Iraq are going to be neighbours for a long long time and they have to try to work these things out."

On Tuesday, Iraqi Airways announced it was ceasing its services to Britain and Sweden, with chief executive Kifah Hassan Jabbar blaming the decision on the legal battle with Kuwait.

Jabbar had his passport seized and the plane he arrived on impounded at London's Gatwick Airport on April 25 as a dispute with Kuwait Airways marred Iraqi Airways's first commercial flight from Baghdad to London in 20 years.

His passport was eventually returned and he was allowed to return home on May 6 after he complied with the court order to provide Kuwait Airways with an affidavit of Iraqi Airways's assets in Britain.

The flight had arrived in London after stopping in Malmoe in Sweden carrying 30 foreign and Iraqi passengers on board, including Jabbar and Iraqi Transport Minister Amer Abduljabbar Ismail.

There have been no further flights.

The dispute with Kuwait Airways is part of a wider row between the two countries resulting from Saddam's invasion of the emirate.

Iraq has said it cannot sustain its reparations payments to Kuwait for the invasion, which it claims are the highest paid by any country in history.