* Croatian general freed after war crimes conviction overturned
* Jubilation on the streets of Croatian capital
* Serbia says U.N. war crimes court lost all credibility (Adds Gotovina, vox pop quotes)
By Svebor Kranjc
THE HAGUE, Nov 16 (Reuters) - The most senior Croatian military officer convicted of war crimes during the Balkan wars of the 1990s was freed on appeal on Friday in a decision that will strain already fraught relations between Croatia and its old enemy Serbia.
General Ante Gotovina was cleared by appeal judges at the U.N. war crimes tribunal after being convicted of targeting hospitals and other civilian sites during a military operation to retake Croatia's Krajina region from rebel Serbs.
Gotovina, hailed as a hero at home but reviled in neighbouring Serbia, was freed along with Croatian police commander Mladen Markac.
Their acquittals were greeted with jubilation in the Croatian capital Zagreb where they received a raucous welcome from a crowd of 50,000 after being flown home by government jet.
"We are so happy to be with you tonight. This is our joint victory. The war now belongs to history, let us turn to the future. Thank you and good luck," Gotovina told the crowd from a stage in the main square wreathed in red smoke from thousands of flares.
"This is a moment of pride and glory for Croatia," said Josip Martinovic, a businessman who had joined the crowd.
But Serbia reacted with anger, saying the tribunal had forfeited the right to be considered neutral.
"It is now quite clear the tribunal has made a political decision and not a legal ruling. Today's ruling will not contribute to the stabilisation of the situation in the region and will open old wounds," Serbian President Tomislav Nikolic said.
The successful appeal marks the biggest reversal for the International Criminal Tribunal for the Former Yugoslavia in its near two decades of hearing cases resulting from the wars that shattered the Yugoslav federation.
Prosecutors had accused Gotovina of illegally targeting civilian institutions in Krajina towns in a deliberate attempt to spread fear to drive Serbs out of the region.
But appeal judges said civilian institutions had not been targeted on purpose, ruling: "Without a finding that the artillery attacks were unlawful, the Trial Chamber's conclusion that a joint criminal enterprise existed cannot be sustained."
The acquittal will further strain ties between the two main actors in the Yugoslav wars - Serbia and Croatia. Relations had improved significantly under pro-Western former Serbian president Boris Tadic, but have soured since the election this year of nationalist Nikolic and Ivica Dacic as prime minister.
"With this, the tribunal has shown that it has finally decided on who was the aggressor and the fact remains that not a single Croatian general who fought in Croatia has been convicted," said Zagreb-based political analyst Zeljko Trkanjec.
The decision provides a boost for Croatia before it joins the EU, vindicating for Croats their 1995 offensive against Serb-held Krajina.
But it could play into the hands of nationalist hardliners in Serbia who accuse the West of unfairly punishing Serbs for the crimes committed during Yugoslavia's collapse.
Gotovina was a commander when the Croatian army, aided by U.S. and NATO military advisers, ousted rebel Serb forces from the Krajina region in Operation Storm in 1995.
Gotovina was jailed for 24 years at the end of his original trial. The former member of the French Foreign Legion was arrested in the Canary Islands in 2005 after years of international pressure on Croatia to hand over war crimes suspects.
Markac, a former martial arts instructor and a co-founder of Croatia's anti-terrorist police, was sentenced to 18 years.
Crowds in Zagreb erupted with joy, clapping and cheering at the acquittals, which were broadcast live by Croatian TV stations.
Prime Minister Zoran Milanovic said Croatia would fulfil its obligation to prosecute crimes from the Yugoslav wars, in which at least 100,000 people died.
"There were mistakes in the war, for which Croatia is responsible and for which it will pay its debt to justice."
Croatian President Ivo Josipovic added: "This confirms that Croatia did not conduct ethnic cleansing."
However, in Belgrade, Serbia's point man for cooperation with the U.N. tribunal reacted angrily to the decision.
"There is no logic. Crimes were indisputably committed during Operation Storm, but so far no one has been sentenced for that," Rasim Ljajic, who heads Serbia's national council for cooperation with the tribunal, told Tanjug news agency.
Cooperation with the tribunal would now be scaled back to technical matters, he said. The tribunal said a conference it was holding in Belgrade next week would not take place.
Gotovina's acquittal is a setback for prosecutors at the ICTY, who have been accused of focussing unduly on Serbian suspects in their investigations of war crimes during the Yugoslav wars.
"The case was motivated not just by the fact of who Gotovina was, but also by the fact that this was the prosecutors' big Croatian case," said Nick Kaufman, a defence counsel at the ICTY and a former member of its prosecutor's office.
"This was their prize Croat war criminal, because otherwise the focus had been heavily on Serbian war criminals," he added.
Since it was set up in 1993, the tribunal has indicted 161 people for crimes committed during the Yugoslav wars, of whom 14 have been acquitted.
Slobodan Milosevic, the Serbian president, was the court's highest-ranking indictee. He died in detention in 2006, before the court could deliver a verdict. Bosnian Serb political leader Radovan Karadzic and his military chief, Ratko Mladic, are currently facing trial. (Reporting by Ivana Sekularac and Gilbert Kreijger in Amsterdam, Zoran Radosavljevic in Zagreb, and Aleksandar Vasovic in Belgrade. Writing by Thomas Escritt; Editing by Jon Boyle and Giles Elgood)