The European Commission proposed on Wednesday that several billion euros of European Union funds for Hungary be frozen until Budapest implements substantial reforms.
The commission wants Hungary to do more to improve the rule of law and fight corruption.
At stake are some €7.5 billion ($7.8 billion) from the EU budget, in addition to €5.8 billion in loans from the bloc's Covid-19 fund.
Efforts by Budapest in recent months to tackle corruption and to improve the rule of law aiming to appease Brussels were not sufficient to unblock the money, the commission said in a statement.
"The direction is still the right one, but we are not yet at the goal," EU Budget Commissioner Johannes Hahn said at a press conference.
The commission approved Budapest's plan on how to spend the €5.8 billion in Covid-19 aid, but stressed that no funds should be paid to Hungary before all demanded reforms are fully implemented, the commission said.
The commission first proposed this in September.
A past commission report spoke of "an environment where risks of clientelism, favouritism and nepotism in high-level public administration remain unaddressed."
The decision from the commission on Budapest's Covid-19 recovery plan "did not come as a big surprise," Zoltán Kovács, a spokesperson for the Hungarian government, wrote on Twitter quoting Tibor Navracsics, the country's minister for regional development.
"Hungary will deliver on the remaining commitments as accurately and thoroughly as it has done so far," he added.
The commission proposal still needs backing by a sufficient amount of EU countries.
Fifteen of the 27 EU states, which together must make up at least 65% of the total population of the EU - a so-called qualified majority, need to approve withholding the funds.
German Foreign Minister Annalena Baerbock backed the commission's decision.
"The rule of law is the backbone of European democracy," Baerbock said on the sidelines of a NATO foreign ministers meeting in Bucharest, adding that the rule of law was also the basis for the bloc's single market.
The commission has long criticized widespread corruption in Hungary, as have other EU bodies like the European Parliament, but this is the first time it has threatened to cut funding.
The process of restricting funding began in April, using new legislation implemented in 2021 aimed at ensuring that EU countries adhere to the bloc's general principles.
A fundamental principle for making use of the law is whether the commission believes EU funds are being misused.
