Illinois facing financial disaster: watchdog CHICAGO (Reuters) - Illinois could see its pile of overdue bills climb to an unprecedented $35 billion in five years if the state fails to rein in pension and other costs, a watchdog group said in a report released on Monday. "Failure to address unsustainable trends in the state's pension and Medicaid systems will only result in financial disaster for the state of Illinois," said Laurence Msall, president of the Civic Federation, the financial government watchdog group that produced the report. Msall said the governor and General Assembly need to act now. The Civic Federation's five-year budget projection showed the backlog of bills owed vendors and others rising to $9.2 billion when fiscal 2012 ends in July. Those numbers could balloon to $34.8 billion at the end of fiscal 2017, the report said. The rise was pegged largely to an unsustainable increase in the state's costs for Medicaid, the health care program for the poor that is jointly funded by states and the federal government. At the end of fiscal 2011, Illinois had about $8.5 billion in bills, tax refunds and other obligations outstanding despite a big income tax rate hike enacted in January 2011, according to the state comptroller. Illinois' fiscal woes and reliance on one-time revenue measures, such as borrowing, have made the state a riskier investment in the U.S. municipal bond market, where it has issued billions of dollars of bonds to make pension payments. Earlier this month, Moody's Investors Service cut Illinois' credit rating to A2, the lowest rating among the states it rates. Medicaid-related bills alone could account for $21 billion of the projected fiscal 2017 bill backlog as Illinois budget appropriations lag rising costs for the program, the watchdog's report said. As for pensions, chronic underfunding, exacerbated by investment losses in fiscal years 2008 and 2009, have left Illinois with a $83.1 billion unfunded liability and a funded ratio of only 43.3 percent, according to the Civic Federation. The group called for curbing pension benefit increases for all retirees and current employees. Illinois has consistently been ranked by the Pew Center on the States as having the lowest pension funding level among states. Meanwhile, Illinois' operating deficit, which is projected at $508 million in the current general funds budget, could jump to $3.2 billion in fiscal 2017 if the state continues to spend more than what it collects in revenue, the report said. A statement from Governor Pat Quinn's Office of Management and Budget called the report constructive and said that Quinn, a Democrat, has proposed reforms such as a reduction in the Medicaid reimbursement rate. It added that Quinn's fiscal 2013 budget plan will "continue to market the tough decisions necessary to address the state's financial challenges." Reporting By Karen Pierog