(Adds Ethiopian denial)

By Andrew Cawthorne

NAIROBI, Dec 8 (Reuters) - Somalia is a shattered nation, the most dangerous place on earth for aid workers and the scene of horrific abuses by combatants on all sides of the conflict, a U.S.-based human rights group said on Monday.

Human Rights Watch (HRW) said fresh thinking was needed by Barack Obama's incoming U.S. administration towards the Horn of Africa nation since policy under President George W. Bush had exacerbated the threat from militants.

"Somalia is a nation in ruins, mired in one of the world's most brutal armed conflicts," Human Rights Watch said. "Two long years of escalating bloodshed and destruction have devastated the country's people and laid waste to its capital Mogadishu."

The HRW report on war crimes in Somalia this year was the latest in a chorus of appeals for international action to stem the chaos. In anarchy since 1991, Somalia is now one of the world's worst, and most neglected, humanitarian crises.

U.S. ally Ethiopia sent thousands of troops into Somalia to topple Islamists at the end of 2006, prompting an Iraq-style insurgency that has killed at least 10,000 civilians, created more than a million refugees, and fomented piracy offshore.

Despite the ever-louder alarms on Somalia being sounded by charities and governments, the world is short of solutions. An African peacekeeping force and U.N.-brokered peace talks with moderates on both sides have had little impact on the ground.

HRW accused Somali security services, Ethiopian troops and allied militia of indiscriminately shelling residential areas, looting and torturing, killing and raping civilians.

Ethiopia reacted angrily to the report, saying its soldiers had acted within the law.

"Ethiopian troops have never carried out mutilations, or indiscriminately bombarded civilian areas as HRW alleged," the Ministry of Foreign Affairs said in a statement.

"HRW's report is based on hearsay and unsubstantiated interviews carried out in Nairobi or in Kenyan refugee camps."

On the other side, Islamist rebels have shelled residential areas and markets, launched attacks from high-population districts, and punished suspected collaborators.

"The full horror of these abuses can be captured only through the stories of Somalis who have suffered," HRW said.

Its litany of witness accounts included a man watching his mother and sisters raped in front of him, children shredded by mortars and a lowly government messenger shot by insurgents.

WORST SINCE GROZNY

HRW said it hoped Obama would break with the U.S. policy of occasional airstrikes against militants in Somalia and support for Ethiopia despite evidence of abuses by its soldiers.

"There is strong evidence that U.S. policies in Somalia have aggravated the very concerns about terrorism they seek to address...The aftermath of U.S. airstrikes has left a more lasting impression in the minds of many Somalis than U.S. funding for humanitarian assistance."

As well as civilians, foreign and local aid workers have borne the brunt of violence this year, with assassinations, attacks and kidnappings increasingly rife. At least 29 aid workers have been killed in 2008.

"Somalia is now the most dangerous place in the world for humanitarian workers," it said.

HRW said the Dadaab camps in Kenya, packed with fleeing Somalis, was the largest concentration of refugees in the world with more than 220,000 people. Much of the report was based on interviews with refugees there and elsewhere.

Large areas of Mogadishu are deserted, with 870,000 people, two-thirds of its residents, fleeing in the last two years. HRW said such destruction of a city was unprecedented since Grozny in Chechnya, devastated in an assault by Russian troops to root out Chechen separatists. (Editing by Ralph Boulton)

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