EU faces dangerous dilemma over financing battle

By Jan Strupczewski

BRUSSELS (Reuters) - Poland's and Hungary's veto of the European Union's 1.8 trillion euro financing package has plunged the bloc into a battle that threatens to damage both its economy and unity at a time when it is already struggling to cope with the COVID-19 pandemic.

The 27-nation bloc faces a dilemma over how to resolve the stand-off and has just a few days to avert a serious crisis.

Following is an explanation of the situation and scenarios for how it could play out.

BACKGROUND

Warsaw and Budapest hold hostage the 1.1 trillion euro ($1.3 trillion) long-term budget and a special 750 billion euro coronavirus recovery fund for all 27 countries because they do not want access to the money to be conditional on them respecting the rule of law.

Both countries are under EU probes for undermining the independence of courts, media and non-governmental organisations, so they risk losing tens of billions in funds.

The rule linking access to EU money with respect for the rule of law does not require unanimity, so Poland and Hungary can be easily outvoted. But the budget and recovery fund do need unanimity and the two countries are exercising their veto power.

To help them withdraw their veto, EU leaders are considering issuing a declaration at a Dec 10-11 summit to make clear that freezing funds for rule of law offenders would be an objective process and subject to verification by the EU's top court.

BEST-CASE SCENARIO

The EU's budget for 2021-2027 is a framework for seven individual annual budgets approved each year.

The deadline for agreeing on the 2021 budget is Dec. 7.

If Poland and Hungary remove their veto by Dec. 7 on the promise of a summit declaration, the EU could approve the 2021 budget, based on the already agreed 2021-2027 framework, and no damage would be done.

SECOND-BEST SCENARIO

If Poland and Hungary do not withdraw the veto by Dec. 7, the chance to agree on the 2021 budget this year will be lost. But they could still remove their veto three days later at the summit, saving at least the deal on the wider 2021-2027 budget and recovery package.

In this case, from Jan. 1, 2021, the EU would move to an emergency funding arrangement called the provisional 12ths because each month the EU would be allowed to spend only 1/12th of what it spent in a certain area in 2020.

Under the provisional 12ths, no new projects would get financing, only those already started under the 2014-2020 budget. Farmers would still receive EU subsidies until 2022, although most likely with a delay and paid out monthly.

If Warsaw and Budapest do back down on Dec. 10, the executive European Commission would quickly prepare another 2021 budget that EU institutions would approve early next year, ensuring the disruption to fund flows is only short term.

WORSE SCENARIO

If Poland and Hungary do not back down on Dec. 10, the EU will have no new long-term budget framework and no annual budget for 2021. Governments would have to pay into the EU budget based on their gross national income.

The EU would finance itself using the twelfths rule, funding only direct subsides for farmers, common foreign and security policy, humanitarian aid and civil protection, but no new projects except legacy ones from 2014-2020.

In this scenario, Poland and Hungary, large net beneficiaries of EU funds, could get 50-75% less money in 2021 even for already existing projects.

This is because the EU would be getting less money from contributions based on gross national income (GNI) due to the current recession and because net contributor Britain will be gone. Higher GNI contributions agreed for the 2021-2027 budget, a solution to that problem, would not kick in.

Funding for the popular Erasmus student exchange programme would stop, as would money for research and development, and new projects like roads, bridges, waste and water treatment plants, green buses and trams for cities, money for miners to find jobs in other sectors or better protection against pandemics.

SCENARIO OF 25

A continued veto from Poland and Hungary freezes the EU's historic plan to jointly borrow 750 billion euros and spend it, as a mix of grants and loans, on stimulating economic recovery.

While the EU cannot bypass the two countries on the bloc's budget, it can do so on the recovery fund using a rule called "enhanced cooperation" that allows at least nine countries to pursue a project on their own.

A European Commission official said this would allow the recovery fund to apply to 25 countries, leaving Poland and Hungary out. Fund money could start flowing around mid-2021, as originally planned.

It is not clear if, as 25, the EU would have to reduce its planned borrowing by the amount originally meant for the two countries, or still borrow the entire 750 billion euros and distribute their shares among others.

($1 = 0.8267 euros)

(Additional reporting by John Chalmers; Editing by John Chalmers and Nick Tattersall)