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BRUSSELS (Reuters) - Standard & Poor's cut its outlook for Belgian debt to negative on Tuesday, flagging a new risk for money markets as investors weighed prospects of higher borrowing costs for one of the euro zone's most indebted states.
If the country's inability to form a government threatened deficit- and debt-reduction goals, S&P said Belgium'S AA+ rating could be downgraded within six months.
The strong warning places Belgium, which has a debt-to-GDP level of almost 100 percent, among the riskier states in a region being pummeled by a debt crisis that has led to bailouts for Greece and Ireland amid concerns Portugal and Spain might need rescuing too.
In the latest in a series of negative rating moves on euro zone states by the three main agencies, S&P said it was lowering the outlook from stable to negative largely because of Belgium's failure to form a new government since elections in June.
Analysts said they were not surprised by S&P's decision, which was a clear sign the country needed to come up with a comprehensive deficit-reduction plan soon.
"The key issue when it comes to Belgium, in contrast to most other euro zone countries, is they don't really have a serious fiscal consolidation package in place and obviously there's the political uncertainty," said Nick Kounis at ABN Amro.
"The deficit doesn't look that bad, but of course the government debt levels are high ... There is the contagion risk in what is still quite a vulnerable environment."
The yield on Belgium 10-year government bonds rose, with the spread over benchmark German Bunds -- a key indicator of investment risk - widening by 10 basis points to 110 bps.
That rise mirrored recent gains in equivalent yields on peripheral euro zone bonds, but Belgium's spreads remain far below those of Greece, Ireland, Portugal and Spain.
"We believe that Belgium's prolonged domestic political uncertainty poses risks to its government's credit standing," S&P said in a statement.
"We could lower the sovereign rating on Belgium one notch if we conclude that the lack of consensus will result in the government not being able to stabilize its debt trajectory. If Belgium fails to form a government soon, a downgrade could occur, potentially within six months."
S&P also had concerns about Belgium's ability to bring its budget deficit down to a target of 4.1 percent next year, and a gross borrowing requirement of about 11 percent of GDP.
Belgium has been without a government since June, when a parliamentary election failed to produce a clear winner. Negotiations over forming a coalition administration have failed to clinch an agreement and there is now the possibility of a new election being held.
Belgian officials have played down the risks, saying most of the debt is 'Belgian-to-Belgian' rather than being money effectively owed to foreign banks and other creditors. But those reassurances may not hold if the debt crisis deepens further.
"Looking at the fundamentals, the Belgian economy does look to be much more shielded than a country like Portugal," said Carsten Brzeski, an economist at ING. "Nevertheless, having no government... does contribute to instability and uncertainty. Belgian politicians need to get their act together."
The International Monetary Fund said on Monday Belgium needed to articulate a plan to reduce its deficit to prevent debt market concerns undermining its economic recovery.
Belgium's gross domestic product is expected to grow by 1.7 percent in 2011 versus about 2 percent in 2010 -- a rate driven by strong exports and inventory rebuilding.
"Financial market concerns about sovereign risks in the euro area, Belgium's high public debt and political uncertainty could dampen confidence, increase financing costs for the economy, and undermine the recovery," the IMF said.
Among other debt agencies, Fitch has Belgium at AA+ with a stable outlook amd Moody's at Aa1.
S&P cut its outlook on Portugal's A- rating on November 30 while Fitch slashed Ireland by three notches to BB+ last week.