In a statement to the Scottish Parliament, Jim Wallace said that following consultation the prison, which houses a specialist sex offenders' unit, would stay open.

Mr Wallace paid tribute to the "world class staff" at Peterhead and what he called a dignified and effective campaign to save the sex offenders' unit.

To applause in the chamber, he confirmed it would stay open and that it would be upgraded.

Jim Wallace promised new investment

However, the opposition parties criticised the minister for performing what they described as a u-turn in the face of overwhelming public opinion.

And campaigners said the minister had failed to allay fears over the prison's long-term future.

A new private jail is to be built in the central belt to deal with the increasing number of remand prisoners and Mr Wallace challenged the public sector to compete for the contract for a second new prison.

The Scottish Executive has been attacked over the record of Kilmarnock prison, Scotland's only privately-run prison.

Mr Wallace said: "I want the Scottish Prison Service (SPS) and the trades unions to show that they have the chance to bridge the gap between the private and the public sector on competitiveness.

'Largest investment'

"If they can produce for me a robust and credible plan for the second new prison, one which is competitive, offers value for money and delivers the places we need on time, I am prepared to take that project forward in the public sector or as a privately-built, publicly-operated prison."

He also announced what he called the largest ever investment in publicly-run prisons.

The minister said that �110m is to be spent over the next three years to upgrade existing prisons in an effort to end slopping out.

This announcement about a new private prison is an absolute betrayal to the people of Scotland

Derek Turner POAS

He said the plans would create 1,100 new or refurbished prison places in the public sector, 700 new places in the private sector and a further 700 through a second prison.

Derek Turner, of the Prisoner Officers' Association Scotland (POAS) said: "We have always said that we would be willing to discuss these issues with the prison service and made offers in the past about private-public partnerships.

"But this announcement about a new private prison is an absolute betrayal to the people of Scotland."

There were indications last month that Peterhead would avoid closure following a high-profile campaign of opposition.

Proposals to shut the north east prison, which houses about 300 sex offenders, were contained in the Prison Estates' Review which was announced in March.

Consultation period

The Victorian jail has established an international reputation as a model for the treatment of those jailed for sex crimes.

Eleanor McNiven, who was involved in the campaign to save the prison, said she was "delighted" that Mr Wallace had decided to save Peterhead from closure.

"But I am a bit sceptical because he does not say for how long. There is no word of long-term investment in Peterhead," she said.

Roseanna Cunningham: "Blindingly obvious"

"They are going to put electric light in and improve sanitation but to me that is just tarting up.

"We were hoping for a new build on the Peterhead site and that is obviously not going to happen with what he said today."

Bob Antczak, of the Peterhead Prison Forum, told BBC Scotland: "We are very happy indeed."

He said it would be "a great relief" to traders in the town, those who provide services to the prison and the prison officers and their families living in Peterhead.

The Scottish National Party welcomed the decision to keep the prison open but criticised Mr Wallace and the executive for their handling of the review.

'Common sense'

SNP justice spokeswoman Roseanna Cunningham said it had taken three years to conduct what she described as "one of the worst parliamentary reviews I have ever seen".

She said: "Can I say that this is a statement of the blindingly obvious and it has been obvious to the people of Scotland - if not to this executive - right from the start that this should be the result."

Scottish Tory justice spokesman Lord James Douglas Hamilton said the decision to retain the prison represented "a victory for common sense".