EU Signals It Can Play Financial Hardball With Budget Holdouts

(Bloomberg) -- As the European Union heads for a showdown with Poland and Hungary over a threat to veto a $2.2 trillion spending package, it has signaled it can significantly cut their funding as soon as next year.

While the EU can’t permanently deprive members of previously agreed funding in times of strain, it can prioritize spending if the new seven-year budget doesn’t take effect from January, according to a diplomat briefed on an EU legal assessment.

If a temporary budget is in place, the EU’s executive can shift around payouts in a way that would delay payments and penalize Hungary and Poland for having caused the deadlock over their refusal to accept rule of law conditions on funding, the legal opinion noted, following an assessment by the legal service of the European Council on the consequences of not adopting the budget on time.

A diplomat familiar with the assessment said it was shared with the Hungarian government in October. Both Hungarian and Polish premiers reiterated on Monday they won’t agree to tying disbursements from the bloc’s budget and virus-recovery fund to upholding the rule of law. They insisted on changing a draft deal that is backed by all other members. The Hungarian government couldn’t be immediately reached for comment.

While this would be a blow to both net beneficiaries of EU funds, it would come at a worse time for Hungarian Prime Minister Viktor Orban, who’s already focusing on 2022 general elections.

Hungary and Poland Unbowed Over EU Budget Deal as Showdown Looms

He has labeled the ballot as the toughest contest in his tenure since his 2010 return to power. Reduced aid from the EU would add to economic pain caused by the coronavirus pandemic.

Hungary and Poland are both under formal EU probes over the erosion of democratic standards, making them prime candidates for potential cuts to funding that could top a combined 180 billion euros ($215 billion) in the coming years.

Orban said Hungary is already preparing for a possible crunch. His government sold 2.5 billion euros worth of Eurobonds last month, taking its annual foreign currency issuance to 6.5 billion euros, the highest since at least 1999.

Risky Strategy

Yet two EU diplomats said Orban will want to avoid a prolonged standoff, as that could be a risky strategy for him to pursue ahead of elections. Despite their leaders’ rhetoric, EU membership is widely supported by Poles and Hungarians.

“When it comes to EU negotiations, we are open to new proposals and convinced that an agreement can be reached, but it must be in line with EU treaties,” Piotr Muller, the spokesman for Poland’s premier, said in Warsaw.

While German Chancellor Angela Merkel called for compromise from both sides, she rejected their claims that a July agreement between EU leaders on the strings attached to disbursements improperly mixes the budget and issues related to democratic norms.

The EU’s legal opinion also explores an unlikely scenario that would see the rule-of-law conditionality forced through over objections from Hungary and Poland and payments to both member states then suspended.

Positions have since become so polarized that France last week floated the idea of cutting out Hungary and Poland from the 750 billion-euro pandemic recovery fund as a possible solution.

At a meeting of EU government envoys in Brussels on Monday, the German ambassador to the bloc said that a decision will be taken by Wednesday on whether a compromise is possible, or the matter will have to be dealt with by leaders themselves at a December summit, according to two diplomats familiar with the meeting.

©2020 Bloomberg L.P.