Toyota Motor Corp, the world's biggest automaker, forecast a much bigger-than-expected $8.6 billion annual loss and said it would sell about 1 million fewer vehicles this year, leaving it desperately trying to cut costs in the grip of a severe market downturn.

The global crisis that has battered demand for cars and pushed U.S. rival Chrysler into bankruptcy has hit Toyota hard, reversing its rapid expansion into overcapacity almost overnight. Dozens of its factories stand half idle.

The Japanese giant posted its first-ever consolidated operating loss last year after a record profit the year before.

For January-March, Toyota booked a $6.9 billion loss, in line with consensus estimates, and cut its annual dividend nearly 30 percent -- the first cut since at least 1994, when it changed its reporting period.

While the entire industry is caught in the slump and seeking to offload cars piled up in stockyards, Toyota has been especially vulnerable due to its exposure to the United States and Japan, where sales have plunged to multi-decade lows.

Even in China, Toyota has bucked the market's rise with a fall so far this year.

Toyota's outlook was worse than I'd expected. The company expects a really tough time for the first six months, said Naoki Fujiwara, a fund manager at Shinkin Asset Management. I expect the bottom for the auto industry is the April-June period, followed by a slow recovery.

Toyota President Katsuaki Watanabe was more downbeat, stopping short of predicting when sales would pick up in major markets, or when the company would return to profitability as it remains saddled with excess capacity.

Of course the external environment doesn't help, but we were lacking in the scope and speed of dealing with various problems and issues, and for that I am sorry, he told a news conference.

For the year to next March, the maker of the Prius hybrid forecast an operating loss of 850 billion yen, more than double the average forecast in a survey of 20 analysts by Thomson Reuters. It sees an annual net loss of 550 billion yen based on the dollar and euro averaging 95 yen and 125 yen.

The bleak forecasts prompted ratings agency Standard & Poor's to downgrade Toyota's long-term debt ratings to AA from AA+, with a negative outlook.

DOWNBEAT ON SALES

Toyota said it expected its global sales, including units Daihatsu Motor Co <7262.T> and Hino Motors Ltd <7205.T> but excluding cars sold by joint ventures in China, to fall about 14 percent in 2009/10 to 6.5 million vehicles.

Watanabe said that would knock 800 billion yen off the operating level this year, which Toyota aims to offset with cost cuts. The bigger loss forecast this year is otherwise due to a stronger yen, he said.

To return to profit, Toyota must sell more cars or cut costs further, Watanabe said. But he predicted the U.S. market would be around 10 million vehicles industrywide at best this year, down from more than 13 million in 2008.

Toyota is hoping the launch this year of a third-generation Prius will ease some of its sales slide and production cuts, even though it is cutting the price of the popular model to bring it closer to Honda's new Insight hybrid, meaning its contribution to profits would be smaller than planned.

Toyota may also benefit from the expected introduction of a cash-for-clunkers scheme in Japan.

CAPACITY PROBLEMS

Toyota is bleeding overhead costs, with about a third of its global assembly lines working on single shifts. It will slash capital spending by more than a third this year to 830 billion yen as it puts expansion projects on hold, but it said it was not thinking of closing any production lines for good.

Toyota reported a January-March net loss of 765.8 billion yen, against a year-ago profit of 316.8 billion yen.

Domestic rival Honda Motor Co <7267.T> last week forecast a small profit for this year thanks to its relatively healthy motorcycle business.

Compared with Honda, (Toyota) has a lot of larger models and a lot of excess capacity globally, said Koichi Ogawa, chief portfolio manager at Daiwa SB Investments. By 2010, cost cutting and capacity reduction may be taking effect, so they could break even then.

Other big automakers are also struggling.

General Motors Corp on Thursday reported a quarterly net loss of $6 billion and said it burned through more than $10 billion as it relied on a federal bailout to ride out the sharp sales decline.

Japan's Fuji Heavy Industries Ltd <7270.T>, in which Toyota has a 16.5 percent stake, forecast its annual operating loss could balloon to 35 billion yen this year from 5.8 billion yen in 2008/09, citing weak global car sales.

Toyota shares closed down 1.5 percent at 3,980 yen ahead of the results. The stock has risen 39 percent this year, while Tokyo's transport sub-index <.ITEQP.T> is up 47 percent.

Toyota's 5-year credit default swap has narrowed to about 151 basis points this week, falling 140 bps from a record peak in mid-March as equity markets have rallied, according to Markit data.

(Additional reporting by Taiga Uranaka and Elaine Lies)

(Editing by Ian Geoghegan)

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