Why Hungary and Poland Are Blocking the EU’s $2.2 Trillion Budget

(Bloomberg) -- Why are Hungary and Poland blocking the European Union’s 1.8 trillion euro ($2.2 trillion) spending plan at a time when the pandemic’s resurgence is causing deep economic pain? Leaders of the two countries say it’s to squelch new rules over the disbursement of aid they say would impose “foreign” values like gay marriage. Other EU countries say the rules are primarily to prevent an unprecedented outpouring of aid from being handed out to cronies. More broadly, they are meant to put teeth into the EU’s so-far unsuccessful efforts to keep Hungary and Poland from backsliding further from the bloc’s core democratic values.

1. What triggered this crisis?

EU leaders unanimously agreed in July to for the first time attach what are known as rule-of-law conditions to the disbursement of EU funds. The move covered a new coronavirus stimulus pact as well as the bloc’s 2021-2027 budget.

2. Did Hungary and Poland object to that?

Yes and no. They agreed to the idea of attaching the conditions, but their leaders insisted the move hadn’t changed their ability to block sanctions. Until now, unanimity was needed and the two countries effectively had each others’ backs. The new rules would allow funding to be cut with the approval of a qualified majority of EU governments. In response, Hungary and Poland have vowed to veto the entire EU spending plan.

3. What are their objections?

They consider the proposal to be a violation of their national sovereignty and a threat to their political projects -- which Brussels sees as at odds with basic EU values on issues ranging from press freedom to the independence of the judiciary and non-discrimination based on sexual orientation. They also consider introducing a new sanctions mechanism contrary to the EU Treaty and argue that it would require an amendment that would need unanimity. Hungarian Prime Minister Viktor Orban said this month that accepting the new criteria would be tantamount to political “suicide” for him. His counterpart Mateusz Morawiecki said that Poland didn’t sign up for this type of EU.

4. Why is the EU insisting on imposing conditions?

The EU has been criticized for funding member states that are undermining its values. While the EU already had a mechanism to resort to when a member state was suspected of committing a serious breach to the rule of law, the procedure -- called Article 7 proceedings -- has been ineffective. Tying aid to funding has been seen as a more effective way to prod governments to adhere to common standards, but it took the economic crisis caused by the pandemic to bring matters to a head.

5. How is that?

The financially conservative richer member states, such as Germany and the Netherlands, agreed to borrowing and spending measures they had long opposed before the crisis. They are in effect lending their stellar credit rating to the EU so it can raise the funds needed for continent-wide economic recovery. They see the rule-of-law conditions as a must for protecting their taxpayers from the misuse of funds by governments they don’t fully trust. EU officials describe complaints about gay rights and immigration by Polish and Hungarian leaders as a diversion.

6. How did the EU get here?

Until Orban’s return to office in 2010, no leader had so brazenly challenged the EU’s fundamental values. His championing of what he calls “illiberal democracy” and his unprecedented power consolidation, including extending his political influence over the media, the courts and even cultural and educational institutions, has made the EU realize that it lacks the toolkit to effectively push back. After Orban’s brand of populist nationalism spread to Poland in 2015, the need to confront the challenge became all the more urgent.

7. What’s being held up?

The European Union has a jointly financed long-term budget, agreed every seven years. Everyone contributes to the joint pot for funding commonly agreed policies, but poorer countries receive back more than they chip in. In that sense, it’s a form of direct fiscal transfers from the rich states to the poor. Poland and Hungary are among the largest net beneficiaries of this budget, which for the period between 2021 and 2027 has been agreed at 1.07 trillion euros in constant prices (around 1.2 trillion euros at current prices). On top of that, leaders last July agreed to allow the EU Commission to raise 750 billion euros (some 800 billion euros at current prices) in jointly backed debt from capital markets to finance the recovery from the virus-induced recession. Most of this debt will be paid back by future EU budgets, where, again, richer countries contribute the most.

8. What’s at stake?

The two countries, which are the only ones in the EU formally being investigated for potential rule-of-law violations, are jointly due to receive at least 180 billion euros ($219 billion) over seven years from the entire package. They may lose out on stimulus funding and the EU executive has signaled it could penalize the holdouts under an emergency budget starting next year by prioritizing disbursements to other nations.

9. How about for the EU?

Even if the EU finds a way to set the recovery fund up outside its normal structures to bypass the Polish and Hungarian veto, the regular EU budget would need the countries’ approval. Without it, the EU would be forced to operate on emergency monthly budgets as of January. This could lead the bloc into a progressive paralysis and many of its flagship spending programs into asphyxiation. It could also provoke a deeper political crisis, as member states wrestle with the question of whether to tolerate what would be seen as an unprecedented attempt at sabotage.

10. How could the conflict be resolved?

At its core the EU is based on compromise and with so much funding at stake, many believe a middle ground may yet be found. But it’s telling that EU leaders are now increasingly talking about a “Plan B” in which Hungary and Poland would be left out of the virus stimulus fund, effectively stripping them of their current veto which applies to its joint financing structure.

11. How have markets been reacting?

While the Polish and Hungarian currencies have wobbled more than usual as the budget standoff hardened, investors have been largely sanguine, believing that it’s in the mutual interest of all parties to cut a deal. Hungary has sold 6.5 billion euros of Eurobonds this year, the most since at least 1999, partly in anticipation of a potential EU financing crunch. Poland’s prime minister said this week that if the country is stripped of EU inflows, it can borrow more on financial markets, where its bond yields are near historic lows. Still, a big drop in EU funding may hinder the ability of both countries to rebound from the coronavirus pandemic and may further hit their currencies and drive up borrowing costs.

12. What’s the longer-term risk for the EU?

The budget standoff has quickly morphed into the most important crisis for the EU following the U.K.’s exit. The risk with Hungary and Poland is that it leads to internal hemorrhaging, potentially paralyzing decision-making. The deadlock may also give a push to the idea of a two-speed Europe -- something that’s been discussed for years -- where a core group of countries agree to further integration, leaving the rest on the peripheries.

13. Might Hungary and Poland leave the EU?

Hungarians and Poles are among the EU’s biggest fans of membership. Despite their frequent EU-bashing rhetoric, the leadership in Budapest and Warsaw both say that it’s in their country’s interest to stay in the bloc, which is not only a major source of funding but their biggest market as well. Still, opposition parties in both countries have said that it can’t be ruled out that the ultimate aim of the current governments is to eventually exit the EU in order to escape oversight. In such a scenario -- and assuming that both administrations are still in power then -- the end of the decade may be the time to do it. That’s when both Hungary and Poland are due to become net contributors to the EU budget for the first time.

The Reference Shelf

• Freedom House’s 2020 report on the extent of democratic backsliding in central and eastern Europe.
• A Bloomberg News story on how cronyism is flourishing under Hungary’s Orban.
• A story on how Poland is weaponizing homophobia for political gain.
• A QuickTake on the culture wars sparked by Poland’s populist rulers.
• An article on the Hungarian-Polish defiance in EU budget talks.

©2020 Bloomberg L.P.