CHICAGO (Reuters) - Illinois’ upcoming elections are casting a shadow over the state’s ability to pass a new budget, tackle its financial liabilities and keep its credit ratings from sinking into junk, analysts said.

Illinois is a prime example of U.S. state fiscal woes. With a huge $129 billion unfunded pension liability and a chronic unpaid bill backlog, it has the lowest credit ratings among states, and political dysfunction left it without complete budgets for an unprecedented two-straight fiscal years.

The Democratic-controlled legislature, with the help of some Republican votes, finally enacted a fiscal 2018 budget in July over Governor Bruce Rauner’s vetoes. On Wednesday, Rauner, a Republican, is set to unveil his fiscal 2019 budget plan.

“This coming budget process is really important for the state’s creditworthiness,” said Gabriel Petek, an analyst at S&P Global Ratings, which rates Illinois one notch above junk at BBB-minus. “The fact it’s an election year usually does not make the process easier.”

He added there was no sign the political battle between Rauner and Democrats that led to the budget impasse had eased.

Rauner, seeking a second term in November, is facing one primary opponent, while six Democratic candidates are also vying for the nomination. In the legislature, 157 of the 177 seats are up for election.

BUDGET TIGHT SPOT

The governor has promised to produce a balanced fiscal 2019 budget that includes a path toward rolling back a $5 billion income tax hike the legislature approved over his veto last year.

Democrats are dubious.

“I’m waiting anxiously to hear his speech and his proposals and see the math of how this works,” said State Representative Greg Harris, House Democrats’ budget point person.

House Speaker Michael Madigan, the target of a long-shot Rauner effort to strip him of his long-time leadership post, has suggested the governor remain on the sidelines this session, while lawmakers work in a bipartisan fashion to move the state forward.

Even if Illinois slows expenditure growth, which has outpaced revenue growth, to the lowest rate among states, it would take almost two decades to achieve a balanced budget, according to David Merriman, co-director of the Fiscal Futures Project at the University of Illinois’ Institute of Government and Public Affairs.

There is limited wiggle room in Illinois’ $37 billion general fund budget. Medicaid, debt service on bonds, pensions, and retiree healthcare account for about 40 percent of spending, compared to a state median of around 28 percent, according to S&P’s Petek.

“Illinois begins its fiscal discussion with less discretion over budget resources than the typical state,” Petek said.

Payments to its five employee retirement funds will jump to an estimated $8.54 billion in fiscal 2019 from $7.99 billion this year with the general fund absorbing 88 percent of the cost, according to an Illinois legislative commission.

The October sale of $6 billion of general obligation bonds to pay overdue state bills will help push GO debt service costs to $4.04 billion in fiscal 2019 from $3.456 billion this year.

Wary bond investors continue to demand much higher yields for Illinois GO bonds compared to other states. Illinois’ so-called credit spread over the municipal market’s benchmark triple-A yield scale for 10-year bonds is 183 basis points. The spread for New Jersey, the next lowest-rated state after Illinois at A-minus, is only 78 basis points.

Eric Kim, an analyst at Fitch Ratings, which rates Illinois BBB with a negative outlook, said while the enactment of a fiscal 2018 budget was a positive step, the election may complicate further progress. He said it was critical for the state to continue to address its big backlog of unpaid bills that ballooned to a record $16.67 billion last year and accrued $1.03 billion in late payment penalties.

The governor’s budget office has warned that without changes to the current trajectory of the state’s finances, the backlog, which stood at $8.67 billion last week, will rise starting in fiscal 2019.

“If (the backlog increases) that certainly would be a concern for us and something we said could be a potential negative rating factor,” Kim said.

(GRAPHIC: Illinois v. New Jersey credit - reut.rs/2BUCEY1)

(GRAPHIC: Illinois unpaid bill backlog - reut.rs/2Bpq81E)