* All Malev flights grounded as of 0500 GMT on Friday
* Comes after EU ruling in January to repay state aid
* Malev accounted for 40 pct of Budapest Airport revenue
* Ryanair, Wizz Air, other low-cost carriers launch flights from Budapest
By Marton Dunai and Gergely Szakacs
BUDAPEST, Feb 3 Hungarian flag-carrier Malev ceased operating early on Friday after its planes were held overseas for unpaid debts, leaving a gap in the market that low-cost competitors were quick to exploit.
Several budget carriers, including Ireland's Ryanair and Air Berlin, announced an immediate increase in their flights from Budapest airport, where state-controlled Malev was a major airline providing 40 percent of revenue.
Prime Minister Viktor Orban told Kossuth radio on Friday that the decision to ground Malev, which ends 66 years of almost continuous service, was made after two aircraft were not allowed to take off from Tel Aviv and Ireland.
Malev said its suppliers had lost confidence and started to demand advance payment for their services, while the government could no longer inject cash following a European Union ruling to claw back millions of dollars of state aid last month.
The airline, which is 95-percent owned by the state after failed privatisation attempts, has a leased fleet of 22 passenger aircraft and employs around 2,600 people. It was placed under creditor protection earlier in the week.
All flights were grounded from 0500 GMT on Friday. A Reuters correspondent at the airport estimated there were about 100 people stranded at terminal 2. Malev's early morning announcement was greeted with scornful cheers and applause by passengers.
"They gave us a bottle of water, and they think this will compensate us for the whole ticket?" said 30-year-old Melinda Kis, who was en route to Copenhagen with her husband and four children.
In December, the government warned the potential loss of the airline, which spent about 50 million euros a year on air service charges and real estate fees, could jeopardise the operation of Budapest airport, owned by Germany's Hochtief and four financial partners.
Airport spokesman Mihaly Hardy told Reuters: "There are some estimates that over 20 or 23 routes of Malev will never be served by other airlines."
Pal Volner, state secretary of the Development Ministry said an increase in low-cost airline traffic may help offset the loss of volume due to Malev's failure.
"Should the airport nevertheless face a problem, that will have to be settled in separate negotiations," Volner said.
LOW COST AIRLINES JUMP IN
Irish low-cost airline Ryanair announced 26 new routes from Budapest on Friday in a move to capitalise on the grounding of Malev.
Ryanair, which in January announced plans to fly five routes from Budapest, has increased that to 31, most of which will be operating by April. It said it will base four aircraft in Budapest and carry up to 2 million passengers per year.
Budapest-based low-cost airline Wizz Air offered to sell 50,000 tickets for 9,900 forints ($45) to holders of Malev tickets for flights in the winter season, which will end on March 24, Wizz Air CEO Jozsef Varadi told a news conference.
Wizz Air, Central Europe's biggest air carrier will raise its Budapest-based fleet to five planes from three.
German flagship carrier Lufthansa < LHAG.DE > said it would add one daily flight from Hamburg and Berlin each to Budapest from Monday. Air Berlin < AB1.DE >, Germany's second-biggest airline, is also adding a flight from Berlin to Budapest.
Czech Travel Service's low-cost airline SmartWings will start flights this month from Budapest to Tel Aviv, followed by Paris in April and several other European destinations in May.
It was not immediately clear whether Malev's halt would automatically trigger a compensation clause in the privatisation agreement the airport signed in 2005 with BAA, which sold it two years later to its current owners.
The Development Ministry said in December the state could be required to pay about 1.5 billion euros ($2 billion) if the airline ceased flying, with "grave consequences for the maintenance of the budget deficit target".
Sources familiar with the situation told Reuters however the amount could be far lower. Hochtief declined to comment.
Prime Minister Orban tried to soften the blow.
"(But) I think restarting is not impossible, and if we can get rid of the burdens inherited from the past, there could still be a Hungarian national airline," he said.
The airline posted a loss of 24.6 billion forints ($110 million) in 2010, but early this month forecast a significant improvement in operating results this year.