OTTAWA (Reuters) - Canada is setting aside C$40 billion ($31.2 billion) to compensate Indigenous children and families in foster care for suffering discrimination, and will start paying out once a protracted lawsuit is settled, officials said on Monday.

       The compensation decision affects some 55,000 children.

       The Canadian Human Rights Tribunal ruled in 2016 that the federal government allocated fewer funds for child and family services of Indigenous people than for others, pushing more Indigenous children into foster care.

       "The government of Canada is provisioning C$40 billion to provide compensation and to commit the funds necessary to implement long-term reform so that future generations of First Nations children will never face the same systemic tragedies," said Indigenous Services Minister Patty Hajdu.

       In October, the government appealed the tribunal's 2019 follow-up order that Ottawa pay each affected child C$40,000. But it said on Monday it would pause the appeal while engaging in talks with the initial complainants.

       "We have made considerable progress... Our discussions remain progressive and productive," Hajdu said a statement.

       The government's legal strategy came under increased scrutiny this year after hundreds of unmarked graves were discovered at the sites of former residential schools.

       Until as recently as 1996, Canada's residential school system separated Indigenous children from their families and sent them to boarding schools where they were malnourished, beaten and sexually abused.

       ($1 = 1.2804 Canadian dollars)

       (Reporting by David Ljunggren; Editing by Dan Grebler)