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BRUSSELS (Reuters) - Serbia agreed to cede its last remaining foothold in the country's former province of Kosovo on Friday, striking an historic accord to settle relations in exchange for talks on joining the European Union.
The deal, brokered by the EU, capped six months of delicate negotiations and marks a milestone for the region's recovery from the collapse of Yugoslavia in the 1990s.
If implemented, it could unlock Serbia's potential as the largest market in the former Yugoslavia, taking the country from international pariah under late strongman Slobodan Milosevic to the threshold of mainstream Europe.
"And the white smoke is out! Habemus pactum! Happy:)))" Kosovo's EU's integration minister, Vlora Citaku, tweeted after the prime ministers of both sides initialled a two-page plan outlining an end to the ethnic partition of Kosovo between its Albanian majority and a small, Belgrade-backed pocket of some 50,000 Serbs in the north.
The schism has dogged regional stability and development since Kosovo seceded from Serbia in 2008.
The Kosovo Serbs will almost certainly resist in a region bristling with weapons and deep animosity, and were already demanding a referendum on the deal.
In exchange for limited autonomous powers for the Serb north, Serbia agreed not to block Kosovo's path to eventual membership of the EU - a concession Kosovo hailed as recognition of independence.
"This agreement is de-jure, legal recognition by Serbia, which will open the way for Kosovo to join international organisations," Kosovo Prime Minister Hashim Thaci, who led a guerrilla insurgency against Milosevic's forces in 1998-99, told reporters.
Serbia says it will never recognise as sovereign a territory it considers the cradle of the Serb nation.
But Friday's deal reflects a sea change in official policy and a realisation in Serbia that it has been swimming against the tide at the expense of its economy.
Neighbouring Croatia, a wartime foe of Serbia during Yugoslavia's demise, joins the EU on July 1, a sobering reminder for many Serbs of just how far they have fallen behind.
Kosovo is recognised by over 90 countries, including the United States and 22 members of the 27-nation EU that Serbia wants to join. But it has yet to join the United Nations, something Serbian ally and U.N. veto-holder Russia holds the key to.
Diplomats said the accord was likely to win a provisional green light on Monday from the EU for the start of membership talks with Serbia. A formal decision would come in June.
The accession process could help unlock the country's potential as the largest market in the former Yugoslavia and lure much-needed foreign investment to its struggling economy.
"It's very important that now what we are seeing is a step away from the past and for both of them a step closer to Europe," said EU foreign policy chief Catherine Ashton, who brokered the deal.
Serbian officials said it remained subject to approval by "state bodies" back in Belgrade. "We will inform the EU by letter on Monday whether we accept the deal or not," Prime Minister Ivica Dacic told reporters.
Western diplomats said there was very little chance of Serbia reversing course, but cautioned that the real test lay in the implementation.
Germany, in particular, "has been very clear on the importance of practical implementation, so that they won't be burned," said a senior Western diplomat, who spoke on condition of anonymity.
Kosovo's Thaci said: "This agreement will help us heal wounds of the past, if we have the wisdom and knowledge to implement it in practice."
Under the terms, the north of Kosovo will be absorbed into the legal framework of the country but retain limited autonomy in areas of health, education, policing and courts.
In a sign of possible resistance to come, Serb municipal lawmakers in northern Kosovo demanded a referendum on whether Kosovo should be part of Serbia or Belgrade should accept the conditions set down by the EU to clinch accession talks.
Steeped in history and myth for Serbs, Kosovo broke away from Serbia in 1999, when NATO carried out 11 weeks of air strikes to halt the killing and expulsion of ethnic Albanians by Serbian military forces under Milosevic waging a brutal counter-insurgency campaign.
Kosovo became a ward of the United Nations, but Belgrade retained de facto control over the northern Serb pocket. The partition has frequently flared into violence and frustrated NATO's hopes of cutting back a costly peace force that still numbers 6,000 soldiers.
"Likely to be taken as a positive by the market, as this will further anchor reforms in Serbia, albeit accession negotiations are likely to be very long," said Tim Ash, head of emerging markets research at Standard Bank.
Additional reporting by Adrian Croft and Justyna Pawlak in Brussels, Fatos Bytyci in Pristina and Matt Robinson in Belgrade; Writing by Matt Robinson; Editing by Mark Heinrich and Mike Collett-White