The Easter Road club chose not to extend 28-year-old’s contract after they failed in their bid to return to the Scottish Premiership at the first time of asking.
Craig returns for a second spell at McDiarmid Park, having previously played for the Perth club between 2007 and 2013.
“It goes without saying that I’m delighted to come back,” he said. “I have a lot of great memories from the last time and I want to play my part in creating new ones and helping the club continue its successes in recent years, particularly the last two.
“Sometimes you just get the right fit and in the time I’ve been back training it’s almost like I’ve never been away.”
Craig impressed St Johnstone manager Tommy Wright following a trial in a recent friendly against David Moyes’ Real Sociedad.
“When a manager makes any signing he’s pleased but the thing about Liam is that I didn’t want him to leave in the first place,” said Wright.
“His experience and knowledge of the club is vital and that came into my thinking. He has a wealth of experience but is still a good age and he has shown in training and in the game against Real Sociedad that he is as good as ever.
“Also, he chips in with goals from midfield and that is something any team needs, so over all I am delighted.”
Craig captained Hibs last season and made 74 appearances for the Edinburgh club, ending in a Premiership play-off semi-final defeat to Rangers.