An Israeli court has set free from house arrest an Australian woman wanted by her country for multiple sexual abuses.

Tuesday's ruling says former principal Malka Leifer is mentally unfit to stand trial. She'll get psychiatric care instead.

Leifer, who ran a school for ultra-Orthodox Jewish girls in Melbourne, fled to Israel in 2008. Australia accuses her of abusing the children in her care and has sought her extradition.

She was arrested by Israeli police in 2014 at the request of Australian authorities. Australia's deputy ambassador to Israel, James McGarry, says his country still "retains a strong interest" in her extradition.

Child welfare advocate Shana Aaronson called the ruling "devastating," saying many victims now live in Israel and fear bumping into their former abuser on the street.