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(Reuters) - Telecommunications equipment maker Alcatel-Lucent will be dropped from France's blue chip CAC 40 index, in a setback for a once high-profile French technology group.

Alcatel-Lucent, stuck in a downsizing spiral as it struggles with stiff competition from low-cost Chinese rivals and weak demand from customers, will be replaced in the index by smart card maker Gemalto, market operator NYSE Euronext said on Thursday.

The changes will take effect on December 24.

Alcatel was a founding member of the CAC 40 when the benchmark was created a quarter century ago. The demotion from the index means the company will be dropped from the radar screens of exchange-traded funds (ETFs) and index trackers, translating into a fall in liquidity of the stock.

Shares of Alcatel have plummeted more than 80 percent since May 2010, with the company's market capitalization shrinking to 2 billion euros ($2.6 billion) - 83rd among France's biggest listed companies.

The stock, worth as much as 97 euros during the tech bubble in 2000, sank to a record low of 71 euro cents in October. It closed at 88 euro cents on Thursday.

"At the time of the merger between Alcatel and Lucent, the group was worth 26 billion euros," said Max Kamir, a trader at Louis Capital Markets.

"I'm very negative on the stock. The company burns a lot of cash. They can have all the restructuring programs they want; without a rise in revenue, the company can't get out of trouble, even with loans and guaranties from the government."

According to index analysts, the estimated selling pressure on Alcatel's stock resulting from the exit from the index would be around 61 million euros, or 69 million shares.

The two official criteria for index inclusion are free-float adjusted market capitalization and a stock's trading volume. But unlike for Germany's DAX, the UK's FTSE 100 and Europe's STOXX 600, there are no specified thresholds for the two criteria, giving leeway to the committee.

Despite trimming its product portfolio and cutting costs, Alcatel-Lucent continues to post quarterly losses and has struggled to build up operating margins amid a brutal competitive landscape.

The group burned through 1 billion euros in the first nine months of the year, prompting management to say it was working on ways to strengthen its balance sheet, including asset sales.

Over the past few months, Alcatel has been one of the favorite European targets for short sellers, who profit from falling stock prices by borrowing shares from long-term institutional investors, selling them on the market, and then buying them back at a lower price.

Alcatel has 12 percent of its shares out on loan, according to Markit data, making it the most shorted stock in the CAC 40 by far, and one of the most shorted stocks across Europe.

A spokeswoman for Alcatel-Lucent said in a statement that the development did not affect the group's listing on the Paris and New York stock exchanges, adding that efforts to cut costs and "install sustainable profitability" would continue.

Meanwhile, the entry of Gemalto to the CAC 40 is likely to raise the profile of the tech group, which posted 2 billion euros in revenue last year from sales of secure chips and software for biometric passports, mobile phones and credit cards.

Gemalto has diversified into the security business in recent years, with a focus on payment technologies and identity management, away from its once core activity of making SIM cards for mobiles, seen under threat from Chinese chipmakers.

With more than 10,000 staff, Gemalto competes against Germany's Giesecke & Devrient in its secure travel documents and mobile payment business as well as companies such as Oberthur Technologies, WatchData and the Morpho unit of Safran <SAF.PA.

Its shares are up 92 percent this year and closed at 74 euros on Thursday.

Kamir said the replacement of Alcatel with Gemalto made sense given that they were both technology stocks. "Gemalto is present in a promising sector and has a leadership position in several areas, unlike Alcatel," said the trader.

(Reporting by Blaise Robinson and Alexandre Boksenbaum-Granier; Editing by Leila Abboud and Steve Orlofsky)

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