Prime Minister Viktor Orban told Kossuth radio on Friday that the decision to ground Malev MALV.UL, which was placed under creditor protection earlier in the week, was made after two aircraft were not allowed to take off from Tel Aviv and Ireland.

In a December white paper, the government said 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.

The airline accounts for 40 percent of turnover at the airport, owned by Germany's Hochtief (HOTG.DE) and four financial partners.

"If this situation continues for a longer period of time, then we will obviously have to revise our business plans for this year and all our contractual obligations," Mihaly Hardy, a spokesman for the airport, told Reuters.

"There are some estimates that over 20 or 23 routes of Malev will never be served by other airlines," he added.

It was not immediately clear whether Malev's halt would automatically trigger a compensation option in the privatisation agreement of the airport first signed in 2005 with BAA, which sold it two years later to its current owners.

In the white paper, the Development Ministry had said the state could be required to pay about 1.5 billion euros in such circumstances, with "grave consequences for the maintenance of the budget deficit target".

The ministry and Hochtief could not immediately respond to Reuters questions on Friday regarding the agreement.

Malev said its suppliers had lost confidence and started to demand advance payment for their services, while the government could no longer provide cash injections for the company following a European Union ruling last month.

"This has accelerated the outflow of cash to such an extent, that by today the situation of the airline has become unsustainable," Malev said on Friday.

"The board, in order to minimise losses, has ordered a halt in operation of the Hungarian national airline."

All flights were grounded from 0500 GMT. The airline's www.malev.hu website was taken offline and replaced with a message informing passengers about compensation options.

A Reuters correspondent on the scene estimated there were about 100 people stranded at terminal 2 of the airport. Malev's early morning announcement had been 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.

ILLEGAL AID

The stoppage comes after the airline was ordered by the European Commission last month to repay millions of dollars worth of state aid received between 2007 and 2010, the equivalent of its entire 2010 revenue.

"It is painful ... We tried to keep Malev operational as long as possible, but we could no longer do it as we would have lost our aircrafts seized abroad ... We had to stop," Prime Minister Orban said.

"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."

Malev has a leased fleet of 22 passenger aircraft.

After failed privatisation attempts, in 2010 Hungary bought back all but a 5 percent stake in the carrier, which employs around 2,600 people.

The government held a series of talks with Chinese carrier Hainan Airlines (600221.SS) last year on a cooperation deal, but they came to nothing.

In a January 9 ruling, the EU Commission listed various forms of state financing for Malev between 2007 and 2010 that it said it would not have been able to obtain from the market on the terms granted by the Hungarian authorities.

The airline posted a loss of 24.6 billion forints in 2010, but early this month forecast a significant improvement in operating results this year.

(Reporting by Krisztina Than; Editing by Will Waterman)

• A Permanent Economic Emergency