Smith, in a statement to parliament, said Australia would also contribute an extra A$8 million ($6.9 million) in aid to Zimbabwe to fund emergency food supplies, agriculture projects and help reinvigorate education.
Smith said more needed to be done to restore democracy and human rights in the country, and to fully implement the power sharing agreement signed a year ago between Mugabe and his political rival Morgan Tsvangirai, now Prime Minister.
"Much more significant progress will be required before the Australian Government undertakes any broader review of Australia's sanctions with respect to Zimbabwe," he said.
The slight easing comes after a European Union delegation visited Zimbabwe and said relations were entering a new phase, although full cooperation hinged on the implementation of the power sharing deal and an end to rights abuses.
Smith said there were growing signs of hope and optimism in Zimbabwe, with major improvements to the country's economy and health system, as well as lower levels of political violence.
Australia in 2002 banned direct ministerial contact with government ministers in Zimbabwe, and in 2004 imposed travel and financial-transaction bans on members of Mugabe's regime and senior supporters.
Australia also tightened scrutiny of student visas for the children of senior Zimbabwean government officials.
It was now time for Canberra to consider working with some Zimbabwean government ministries and to look at direct ministerial engagement with some government members, Smith said.
"Australia will consider opportunities for ministerial engagement on a selective case-by-case basis with those ministers of the Zimbabwean government who we judge to be making a real and genuine contribution to Zimbabwe's social and economic recovery," he said.
