The US embassy resumed sending convoys out with Blackwater guards on Friday - just a few days after the Iraqi government ordered the company's operations frozen.
The Iraqi government, which concluded that Blackwater employees fired without provocation into civilian cars last week, now says the company will be allowed to keep operating for the sake of security.
Tahseen al-Sheikhly, an Iraqi government spokesman, said: "If we drive out or expel the company immediately there will be a security vacuum that will demand pulling some troops that work in the field who protect these institutions and that will create a security imbalance."
This, despite Nuri al-Maliki, Iraq's prime minister, saying Blackwater's alleged misconduct is a challenge to his country's sovereignty.
Attending the UN's special meeting on Iraq, al-Maliki said: "When there is a private company that has committed seven reported crimes already, that is something that we cannot turn a blind eye to."
Baghdad and Washington announced they would take a broad look at the private security firms operating in Iraq.
Rear Admiral Mark Fox, a US military spokesman, said: "That is an opportunity for the government of Iraq and the US government to jointly review and assess how private contractors, in terms of the security mission, are conducting their business."
But senior Iraqi officials had officially complained to the US command for months about the way Blackwater was operating without regulation or oversight.
They said Blackwater refused to obtain an operating licence, submit to weapons inspections or answer questions about previous incidents.
Hussein Kamal, the deputy interior minister, said: "We tried several times to contact the US government through administrative and diplomatic channels to complain about the repeated involvement by Blackwater guards in several incidents that led to the killing of many Iraqis, but there were no concrete results. Our complaints went nowhere."
Iraqi officials say the government may try to file criminal charges or sue Blackwater in a US court.