(Reuters) - Illinois will see next week if yield-hungry investors will continue to snap up its bonds despite concerns about its huge unfunded pension liability and structural budget deficit.

The state will sell about $1.8 billion of general obligation refunding bonds through Jefferies & Co on Tuesday, adding to the $1.375 billion of debt it sold in the first quarter. Illinois' last sale of $500 million of GO bonds in March attracted orders for $2.3 billion, allowing the state to boost the size of the deal and cut yields.

The credit spread for 10-year Illinois GO bonds had crept up to 168 basis points over Municipal Market Data's benchmark triple-A scale as of Thursday after holding steady at 152 basis points for most of April, according to MMD. The spread for California, another lower-rated state, was only 87 basis points in the week ended April 20.

Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management, said on Friday Illinois bond sales have benefited from manageable supply levels so far this year.

"They've been riding the wave that comes with technical support from a shortage of municipal bonds," he said.

And while Governor Pat Quinn last week laid out ambitious plans to reduce spending on Medicaid, the healthcare program for the poor, and tackle the state's $83 billion unfunded pension liability, Ciccarone said there is no guarantee the proposals will make it though the General Assembly.

"They're moving in the right direction, but in Illinois you want to see what changes are enacted," he said.

Standard & Poor's Rating Services last week affirmed the state's A-plus rating with a negative outlook and reiterated a warning that a multi-notch downgrade could happen if the state fails to make progress on its fiscal problems.

Moody's Investors Service dropped Illinois in January to A2, the lowest rating level among the states it rates. Continued...