DILI, Nov 18 (Reuters) - A 29-year-old man was decapitated in an attack thought to be linked to gang violence in East Timor, a hospital official and a relative said on Sunday.

The man was attacked with a sword outside a store near the parliament building in the capital Dili by a group of men waiting in a taxi, a relative of the dead man said.

An official at the national hospital in Dili, where the body was taken, said the victim's head had been severed from his body in the attack and police were investigating.

The former Portuguese colony was plunged into chaos last year after the sacking of 600 rebellious soldiers triggered violence that killed 37 people and drove 150,000 from their homes.

Foreign troops had to be brought in to restore order and security has improved, although sporadic violence, vandalism and arson persist, with an unemployment rate of around 50 per cent helping fan a gang culture among bored youths.

Last week, a man died after an arrow pierced his heart during gang fighting in districts near East Timor's capital.

Indonesia annexed East Timor in 1975 after long-time colonial power Portugal had set it free.

East Timor voted for independence from Indonesia in a violence-marred referendum in 1999. It became fully independent in 2002 after a period of U.N. administration. (Reporting by Tito Belo, Writing by Ed Davies)

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