Home Depot has recommended Anaglipta (sp?) paper
or prime the walls, fill with a flexible drywall compound,
sand compound, prime again and then paint.

I tried the flexible drywall compound on my 1979's vintage
panelling.......it was awful. Tons of work, more than if I'd just
ripped off the panelling and put up new sheetrock. To make things
worse, the spackle in a couple of the grooves bubbled up about a month
after I'd completed the project.

I'd recommend ripping out the panelling (and sheetrock underneath, if
any) and drywalling.

Good luck.

Mr Fixit eh