Libyan leader Muammar Gaddafi and Italian prime minister Silvio Berlusconi signed an accord on Saturday under which Italy will pay billions of dollars in investments and compensation for its colonial rule of the North African country.

The 'friendship pact' accord should remove the latest hurdle to an improvement in ties between Italy and Libya, a major energy producer.

Gaddafi and Berlusconi signed the pact at a palace which was once the headquarters of the Rome government's senior official during the 1911-1943 colonial rule, Libyan state television showed.

Libya accuses Italy of killing thousands of Libyans and driving thousands more from their villages and cities during that era.

Berlusconi said on arrival that under the deal $200 million per year will be invested by Italy in Libya over 25 years. ''Italian companies will set up more business in Libya,' he added, without giving details.

Italian officials said earlier the deal covered 'some billion dollars' in compensation and $5 billion in investments, including the construction of a highway across Libya from the Tunisian border to Egypt.

It also involves a project to clear mines dating back to the colonial era.

Italy expects in return to win energy contracts and for the Tripoli government to toughen security measures to stem the flow of illegal migrants, including joint maritime patrols.

In a goodwill gesture on Saturday, Italy returned an ancient statue of Venus taken to Rome during colonial rule, Libyan state media reported.

The headless 'Venus of Cyrene' was carried away from the town of Cyrene, an ancient Greek colony, by Italian troops and put on display in Rome.

Italy has had difficult relations with Gaddafi since he took power in 1969. He expelled Italian residents and confiscated their property in 1970.

Rome has backed Tripoli's drive to mend fences with the West, which have improved dramatically since 2003 when Libya accepted responsibility for the 1988 bombing of Pan Am Flight 103 over Lockerbie, Scotland.

Libya has also said it would stop pursuing nuclear, chemical and biological weapons.

On August 14 Libya signed a deal with the United States to settle both countries' claims for compensation for bombings.-Reuters