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Are you actually running a X server on the machine from where you telneted from and did you give permission for the remote machine to use its X server? I'd recommend you just use MobaXterm instead of telnet as it has its own build in X server and DISPLAY forwarding and Xauthority permissions are all done for you automatically.
Thank you for your respond.
Problem has been resolved.
I had few 'environment' files executed upon login in .profile.
When I commented them out - all started working perfect.