BRUSSELS EU finance ministers are planning to freeze 495 million euros in aid to Hungary on Tuesday for failing to control its budget deficit, diplomats said, probably marking the first time the bloc withholds funds to punish lax fiscal policy.
A large majority of the 27 ministers are prepared to vote in favour of a proposal from the European Commission, the EU's executive, to suspend the funds for a year from next January, four diplomats said.
"There is a consensus to suspend the cohesion funds to Hungary," said one senior EU diplomat privy to discussions ahead of Tuesday's meeting in Brussels, referring to development money for poorer EU states.
A draft EU statement obtained by Reuters on Monday outlined the ministers' common position and the pressure on Budapest.
Hungarian Prime Minister Victor Orban, who is seeking an International Monetary Fund standby loan to cut his country's borrowing costs, has said the expected decision was "a technical issue", and that Hungary would not lose any EU funds in 2013.
But expectations that the funds will be suspended underscored investors' concerns that Hungary's path to securing financial aid from the EU and the Fund could be difficult.
The forint fell 0.6 percent against the euro after the news to 295. By 1716 GMT it had regained some ground to 293.4, but was still weaker by 0.8 percent from Friday's close.
The EU's move is partly designed so that the Commission can show that its new powers to police member states' budgets constitute a genuine threat, diplomats said. The Commission wants to pressure other EU governments to stick to their fiscal targets despite the economic slump in Europe, which is likely to reduce governments' tax receipts.
"The message is clear to Hungary but to others too: you have to meet your budget commitments to regain the confidence of the markets," said a second diplomat, who added that almost all of the EU's 27 members were in favour of the suspension.
States including Italy, whose debt servicing costs rose to near unaffordable levels late last year, are lobbying for more flexible treatment of heavily indebted countries. Madrid said this month it will violate a budget deficit target of 4.4 percent of GDP agreed with the Commission for this year.
Two years into the euro zone's sovereign debt crisis, Germany, the European Central Bank and the Commission have pressed the currency area's 17 members to commit to austerity to bring down fiscal accounts bloated by the boom years of easy credit following the introduction of the euro in 1999.
This month, EU states except for Britain and the Czech Republic signed a fiscal pact to tighten budget controls.
The EU has long had a rule stating that EU governments' deficits must not be bigger than 3 percent of GDP - the so-called Stability and Growth Pact.
But the Commission's attempts to impose this collapsed in 2003, when Germany and France both missed budget deficit targets and rejected being disciplined. The pact has since been revamped and now contains automatic sanctions for euro zone members.
For poorer states such as Hungary, withholding development funds is the biggest stick the EU can wield. Although the threat has been a reality since new rules were drawn up in 2006, it has never before been enacted.
The EU's executive says Hungary, which under Orban has pursued unorthodox economic policies, has failed to bring its fiscal deficit to within the 3 percent threshold since joining the bloc in 2004.
While it did reduce the deficit to below that level last year, that was mainly due to the transfer of private pension funds to the government, which produced a one-off budget surplus last year. The Commission says this move was neither sustainable nor a structural correction to the earlier deficits.
Hungary has until September to show the Commission it can achieve a sustainable adjustment to its deficit and go below 3 percent next year after phasing out such one-off measures.
Hungary's deficit could be as high as 3.6 percent of GDP in 2013 if Budapest does not take new measures, according to a draft statement prepared by EU officials.
The funds for Hungary can be released as soon as the Commission is happy that Budapest will meet the targets.
"There will be no impact on the Hungarian economy," said a diplomat. "This is money that would be committed from next year to projects for the country, so no real money is being withdrawn," the diplomat said. "It's a wake-up call."
(Additional reporting by Krisztina Than and Sandor Peto in Budapest and John O'Donnell in Brussels; Editing by Sebastian Moffett/Catherine Evans)