By Lewis Jackson

SYDNEY Australia's financial position will be more precarious and credit rating at risk should the government succumb to the temptation to spend the sovereign wealth fund on political projects, its outgoing chair said in a speech on Monday.

The A$205 billion ($130 billion) Future Fund will come under pressure to fund state priorities as an aging population reduces taxpayers and consumes a larger chunk of spending, Chairman Peter Costello said on Monday at a UBS conference in Sydney.

"As government's financial position declines, I expect we'll see more plans to spend it," he said.

"Once it is spent there is nothing to offset government sovereign debt, unfunded pension and unfunded military claims. Once it is spent the pressure to raise taxes and borrow more will accelerate."

The comments come amid calls from the centre-left Labor government for the A$2.4 trillion pension sector to invest in domestic priorities ranging from renewable energy to social housing, although the sector has said investments cannot supersede fiduciary duties to members.

Costello, who previously served as treasurer in centre-left Liberal governments, said the Future Fund's existence was a "buttress" for Australia's AAA credit rating.

Costello will step down in February after two terms as chairman.The Future Fund, set up in 2006 with the proceeds from the privatisation of state telco Telstra, missed its mandated 10% return target last financial year and underperformed several of the country's largest pension funds.

The fund held more cash and less equities than peers and Costello has previously said markets were downplaying the risk of higher-for-longer inflation and the China slowdown.

($1 = 1.5716 Australian dollars)

(Reporting by Lewis Jackson; Editing by Stephen Coates)