CHICAGO Jan 11 (Reuters) - Illinois' inability to resolve its huge public pension problem led Fitch Ratings to warn on Friday it could cut the state's general obligation rating, affecting about $26.2 billion of outstanding debt, if there is no meaningful fix.
Fitch, which rates Illinois at A, pointed to the lack of action on a pension reform plan during the state Legislature's lame-duck session that ended on Tuesday.
"Fitch believes that the burden of large unfunded pension liabilities and growing annual pension expenses is unsustainable," the rating agency said in a statement.
It added that pension reform "is critical to the long-term stability of the state's fiscal position," noting that Illinois constitutional protections of pension benefits is strong and that any pension changes are likely to be challenged in court.
Illinois has the most underfunded pension system among states and Governor Pat Quinn and lawmakers have struggled to come up with a solution to ease the $96.8 billion unfunded liability.
Fitch said it will assess how the state addresses the problem in the next six months and it warned that failure to achieve "meaningful results" would lead to a rating downgrade.
A spokesman for Quinn said the emergency is not going away.
"The Fitch report speaks for itself," said Abdon Pallasch, an assistant budget director. "This should be required reading for every member of the new General Assembly."
The Democratic governor has repeatedly said that ballooning annual pension payments are siphoning money needed for core state services such as education, health care and public safety. He has also warned Illinois risks having its credit rating hammered lower, forcing the state's borrowing costs to rise.
Moody's Investors Service said last month it could downgrade the current A2 rating, the lowest among states its rates, if a pension fix remains elusive. Standard & Poor's Ratings Services dropped Illinois to A with a negative outlook in August due in part to the pension problem.
But majority Democrats did not call up any reform measures for a vote earlier this week as public labor unions made it clear they would challenge diminished pension benefits in court.
In the new legislative session that began on Wednesday, some lawmakers reintroduced pension reform bills from the previous session.