The move is part of a recent warming between Iraq's Shiite-led government and its mostly Sunni Muslim neighbors. Washington has pushed Gulf states like the UAE to restore ties with the war-torn country. Jordan named an ambassador last week, and Kuwait and Bahrain say appointments are imminent.
The Emirates' official news agency, WAM, quoted the country's president, Sheik Khalifa bin Zayed Al Nahyan, as saying he hoped canceling the debt would lighten the "economic burden" facing Iraqis, who he urged to unite behind al-Maliki's government.
WAM said the debt was $4 billion not including interest. A UAE official who spoke on condition of anonymity because he was not authorized to speak to the media said the total debt was $7 billion when interest was added.
The Bush White House applauded the Emirates for forgiving the debt and resuming diplomatic operations in Iraq, reports CBS News Correspondent Mark Knoller.
"The United States welcomes the announcement by the United Arab Emirates to cancel Iraqi debt, appoint an ambassador and reopen their embassy in Baghdad," said White House Spokesman Gordon Johndroe. "We appreciate the Emiratis' recognition that a secure and prosperous Iraq is in the interests of everyone in the region. Prime Minister Maliki and the Government of Iraq should also be applauded for their continued outreach to their neighbors, and their efforts to advance a positive agenda through regional diplomacy."
The announcement came as Iraqi Prime Minister Nouri al-Maliki was visiting the Emirates. An Iraqi government spokesman, Ali al-Dabbagh, confirmed his government was notified of the debt cancellation.
Al-Dabbagh also said Abdullah al-Shehi, the UAE's former head of mission in India, was named ambassador to Iraq. The country said last month that an appointment was upcoming.
The UAE withdrew its ambassador to Iraq after the 2003 U.S.-led invasion and after one of its diplomats was kidnapped and later released.
Sunni militant groups like al Qaeda in Iraq, mistrustful of Iraq's Shiite government, have warned Arab states not to open embassies in Baghdad. The capital's first major car bomb of the war struck the Jordanian Embassy, killing 19 people. Diplomats from Egypt, Morocco, Bahrain, Turkey and Sudan have all been either killed, wounded or kidnapped in Iraq.
The U.S. has sought to blunt fears among Sunni Arab countries like the Emirates and Saudi Arabia over Iran, the largest Shiite Muslim nation, which has been expanding its influence inside Iraq - also a majority Shiite country.
Al-Maliki chided his Arab "brothers" at an April conference of Iraq's neighbors in Kuwait, saying he found it "difficult to explain why diplomatic exchange has not taken place."
"Many foreign countries have kept their diplomatic missions in Baghdad and did not make security excuses," al-Maliki said at the time.
Iraqi officials have also been appealing for relief of at least $67 billion in foreign debt - owned mostly to Arab countries that have been reluctant to forgive Iraq's belligerence during Saddam Hussein's regime.
In addition, the U.N. Compensation Commission says $28 billion remains to be paid for Iraq's 1990 invasion of Kuwait. Iraq now gives 5 percent of its oil revenue to meet the compensation claims.
Last year, Saudi Arabia announced it would forgive the portion of Iraq's debt it holds, but the Iraqi government has said it has so far failed to do so. American officials have urged patience, saying debt relief takes time.
Emirati president Sheik Khalifa bin Zayed Al Nahyan said Sunday to WAM he hoped canceling part of the debt would "lighten the economic burden facing Iraqi people."
Khalifa also urged Iraqis to unite behind the Shiite-led government and praised its efforts to restore the country's stability and security.
American Soldier Dies, U.S. Death Toll Up To 4,114
The U.S. military said an American soldier in Iraq has died of a non-combat cause.
A military statement says the soldier died Saturday.
The statement released Sunday does not elaborate. It says the soldier was assigned to Multinational Corps-Iraq.
An unofficial count by The Associated Press shows at least 4,114 members of the U.S. military have died in Iraq since the war began in March 2003.
Car Comb Explodes In Shiite Neighborhood
A car bomb in northern Baghdad killed six people and injured 14 others, including three policemen, Iraqi police and medical officials said.
The officials, speaking on condition of anonymity, said Sunday's bombing occurred in the predominantly Shiite Shaab neighbourhood.
The injured were taken to al-Kindi Teaching Hospital in the Nahda neighborhood, where AP Television footage showed some of the injured receiving treatment.
Speaking to AP Television, Dr. Ali Abdul-Rahman said the hospital had received five cases, "one was dead and the others are wounded."
The attack comes after Iraq's Prime Minister Nouri al-Maliki said on Saturday that, in a sign of growing confidence after recent crackdowns against Sunni extremists and Shiite militias.
Al-Maliki launched the crackdowns to extend the authority of the government over areas in Baghdad and elsewhere that have largely been under the control of armed groups since the U.S.-led invasion in 2003.
Although violence in the country has fallen to its lowest level in four years, daily attacks continue throughout Iraq.