Legal documents transferring sovereignty were handed over by U.S. governor L. Paul Bremer to chief justice Midhat al-Mahmood in a small ceremony in the heavily guarded Green Zone. Bremer took charge in Iraq about a year ago.
"This is a historical day ... a day that all Iraqis have been looking forward to," Iraqi President Ghazi Al-Yawer said. "This is a day we are going to take our country back into the international forum."
Militants had conducted a campaign of car bombings, kidnappings and other violence that killed hundreds of Iraqis in recent weeks and was designed to disrupt the transfer, announced late last year by U.S. President George W. Bush's administration. Initially, the Americans were thought to have planned for about one more year of occupation.
Two hours after the ceremony, Bremer left Iraq on a U.S. Air Force C-130 plane.
The response in Baghdad to the handover was mixed.
"Iraqis are happy inside, but their happiness is marred by fear and melancholy," artist Qassim al-Sabti said. "Of course I feel I'm still occupied. You can't find anywhere in the world people who would accept occupation. America these days, is like death. Nobody can escape from it."
The new interim government was sworn in six hours after the handover ceremony, which Western governments largely praised as a necessary next step.
The Arab world voiced cautious optimism but maintained calls for the U.S. military to leave the country quickly.
Russia pledged it was ready to work with Iraq's new interim government to help it win the support of the Iraqi people.
Interim Prime Minister Iyad Allawi delivered a sweeping speech sketching out some of his goals for the country, urging people not to be afraid of the "outlaws" fighting against "Islam and Muslims" and assuring them that "God is with us."
"I warn the forces of terror once again," he said. "We will not forget who stood with us and against us in this crisis."
The NATO alliance quickly said it would begin training the Iraqi military, which faces a daunting task in putting down the growing insurgency threatening the country.
Bush celebrated the transfer with a whispered comment and a handshake with British Prime Minister Tony Blair, gathered with world leaders around a table at a NATO summit in Istanbul, Turkey.
Stealing a glance at his watch to make sure the transfer had occurred, Bush put his hand over his mouth to guard his remarks, leaned toward Blair and then reached out to shake hands. Defense Secretary Donald Rumsfeld, a row behind the president, beamed.
Bush was briefed Sunday that the Allawi government was ready to take power early.
The early transfer had been under discussion between Allawi and U.S. officials for at least a week, a senior administration official said, speaking on condition of anonymity.
Although the interim government will have full sovereignty, it will operate under major restrictions -- some of them imposed at the urging of the influential Shiite clergy which sought to limit the powers of an unelected administration.
For example, the interim government will only hold power seven months until, as directed by a United Nations Security Council resolution, there must be elections "in no case later than" Jan. 31.
The Americans will still hold responsibility for security.
And the interim government will not be able to amend the interim constitution. That document outlines many civil liberties guarantees that would make problematic a declaration of emergency.
As Iraq's highest authority, Bremer had issued more than 100 orders and regulations, many of them Western-style laws governing everything from bankruptcy and traffic, to restrictions on child labor and copying movies.
Some are likely to be ignored. One law requires at least a month in jail for people caught driving without a license -- something many Iraqis do not have. Another demands that drivers stay in a single lane, a rule widely ignored in Iraq's chaotic streets.
Others are more controversial. On Saturday, Bremer signed an edict that gave U.S. and other Western civilian contractors immunity from Iraqi law while performing their jobs in Iraq.
The Coalition Provisional Authority's laws remain in effect after the occupation ends unless rescinded or revised by the interim government, a task that another Bremer-signed law allows, but only after a difficult process.
The new government's major tasks will be to prepare for elections, handle the day-to-day running of the country and work along with the U.S.-led multinational force. The Iraqis can in principle ask the foreign troops to leave -- although that is unlikely.
In Moscow, Foreign Ministry spokesman Alexander Yakovenko said in a statement that the efforts of the new Iraqi government "should be directed toward achieving peace and a stable level of security, restoring the economy and respecting the rights and liberties of all its citizens.
"Russia is ready to provide the interim government of Iraq the necessary assistance with this, both within the international community and on a bilateral basis," he said.
Russian lawmakers warned that the new Iraqi government required widespread support as it begins work, particularly in its efforts to stem the violence that has destabilized postwar Iraq.
"The fate of the [Iraqi] government and the country as a whole hinges on their success or failure in this direction, it can be said without exaggeration," said Konstantin Kosachyov, chairman of the State Duma's International Affairs Committee.
Mikhail Margelov, chairman of the International Affairs Committee in the Federation Council, said that real change in Iraq including an improvement in the security situation is not likely to come until after elections are held and a democratically chosen government takes over.
"I think sometime the president of the United States will remember with yearning the time when Saddam was controlling the situation in Iraq," said Duma Deputy Viktor Alksnis of the nationalist Rodina bloc.
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