Work started on a $5.2 billion expansion of Panama's famous canal, the largest-ever overhaul of the short cut between the Pacific and Atlantic oceans.

In blistering heat and occasional storms, thousands of Panamanians gathered at Paraiso, a village north of Panama City, to watch an enormous explosion bite into a hill, marking the start of works that will double the canal's capacity.

The canal expansion is expected to be completed by 2014, in time for the centenary of its opening. The waterway, which was US territory until it was returned to Panama, handles 5 per cent of world trade.

The father of President Martin Torrijos, popular military leader Gen Omar Torrijos, signed treaties in 1977 with the then-US president Jimmy Carter, in which the US agreed to hand over the canal in 1999.

Carter was present for the start of the expansion works and he stood by his decision to give the 80-km waterway back to Panama. Despite the US dominance, Carter said its leaders should show respect to other countries.

"Many leaders in the US said that we should ignore Panama's concerns and said that if we accept it would be a serious error and sign of weakness," Carter said at the groundbreaking ceremony.

But amid the festivities there was a reminder of the bloody cost of the canal. A worker preparing the event was killed on Sunday when his truck hit an electric pylon.

Opened in 1914 at a cost of $375 million and 25,000 lives, the canal was dynamited and dug out by thousands of labourers, braving malaria and yellow fever. The canal saves ships a long haul around South America's treacherous Cape Horn.

This first phase of the project will involve dry excavations of the 218 metre wide trench linking the Culebra Cut with the Pacific coast. It will involve the removal of 47 million cubic meters of earth and rock.

The tendering process for the $3 billion plus project to build a new set of locks is expected to start later this year. Reuters