An Overview of the Rule of Law: the Case of the RRF and Hungary

Background

On 19 February 2021, the Recovery and Resilience Facility (RRF) regulation entered into force. Its main objective was to tackle the impact of the Covid-19 pandemic and to promote economic, social and territorial cohesion through structural reforms and public investment (Afman et al., 2021). The legislative procedure to approve the RRF came with hurdles and divisions among the Member States, where three main issues stood in the way of reaching an agreement: the allocation criteria for distributing the grants, the decision to partially finance the RRF through joint public debt, and whether it should be linked to the mechanism of the rule of law.

The European Commission and the Parliament, on the one hand, envisaged linking the funds to the rule of law. On the other hand, the Council argued that the financial consequences of a violation should be calculated based on the gravity of the potential impact on the financial interest of the Union, and not only based on the breaches of the rule of law (Dimitrovs & Droste, 2020). Hungary and Poland criticised the decision and threatened to veto the budget and resources of the RRF, not only because of the financial arrangement but because they would be among the biggest beneficiaries. Some argued that the regulation does not go as far as it should (Dimitrovs & Droste, 2020). Given this, questions arise as to whether the European Commission is exceeding its powers, and how a blockage of funds would affect those countries at stake. However, the political stance on EU values that the Commission would exhibit if the mechanism of the rule of law ends up not being tied to the funds is controversial.

Austria, Denmark, the Netherlands and Sweden, critical of debt mutualisation and higher EU budgets, ended up accepting the RRF in exchange for a higher level of conditionality (De la Porte & Dangis Jensen, 2021). The need to unlock the financial resources quickly led to an agreement with the Polish and Hungarian governments by which a proper assessment of a breach should be carried out beforehand, delaying the application of the mechanism. The deal toned down the funds’ connection to the rule of law. However, the agreement reached by the Council and the Parliament still yielded funding cuts for Member States if they forsake their commitments to the mechanism (Hillion, 2021).

Rule of law conditionality – what is the current situation?

The rule of law represents one of the core values of the Union, a “common principle” which managed to be equally represented in all constitutional traditions in Europe (Pech, 2009). It is enshrined in Article 2 of the Treaty on European Union (TEU). Although departures from the EU Rule of Law have occurred in the past, since the 2010s, Member States have been increasingly contravening the EU’s liberal democracy and undermining the European conception of the Rule of Law to the extent of creating an internal crisis within the EU (Kelemen, 2020). Notably, Hungary has been transformed into a country with a semi-authoritarian regime, where the central powers are restraining the independence of the judiciary, the civil service, the public bodies essential for the rule of law,  the freedom of the media (Bugarič, 2018), and where agricultural funds have been misused due to corruption. After legitimately becoming Prime Minister in 2010, Viktor Orbán used his constitutional majority to alter the Hungarian Constitution, enacting thousands of laws as well as filling the formerly independent public institutions with his supporters (World Justice Project, 2022).

In response, the Commission issued fierce criticism through the Venice Commission, having found that “systemic threats to the Rule of Law may exist” and proposed a dialogue with the Member State, followed by an objective assessment and concrete actions to avoid the use of Article 7 TEU mechanism (Commission, 2014). Nonetheless, the soft law mechanisms failed. Hence, the European Parliament launched the Article 7 procedure against Hungary in September 2018.

To counteract any future issues, the EU passed the Conditionality Regulation in 2018, allowing the EU to cut funding to states where Rule of Law violations interfere with the proper spending of EU funds. Yet, Hungary and Poland have managed to water down the regulation through stalling by merely allowing cuts on spending of funds directly affected by Rule of Law interferences (Le Monde, 2020). For instance, if the delegation of spending is made by a non-independent body or if the public prosecutor does not prosecute acts of corruption towards EU funds by the ruling party, then only those funds shall be withdrawn (World Justice Project, 2022). Nevertheless, the battle continued as Hungary and Poland  pushed against the resolution in the European Council meeting, with the latter being forced to instruct the Commission to pause the Regulation until its legality was adjudicated in the Court of Justice (European Parliament, 2021).

Is the European Commission exceeding its powers by adding the rule of law as a condition for RRF funds?

1. Insufficiency of Article 7

On a closer reading of Article 2 TEU, the article does not give the Union extra competencies, but only lists values that Member States must respect (Council of the EU, 2014). Yet scholars have argued that, since the article has an unrestricted scope of application, it can apply to states irrespective of any link to provisions of EU law including Article 7 (Spieker, 2019). Accordingly, Article 7 allows one third of Member States, the European Parliament, the Commission, or the Council (the latter acting by majority of four fifths) to determine “a clear risk of a serious breach of the values referred in Article 2”. It allows the Council to impose restrictions on states such as suspending voting rights (Article 7(3)). Yet, the existence of a “serious and persistent breach” (Article 7(2)) can only be determined in the Council by unanimity, (Pech, 2009).

For the RRF, one may argue that the use of the Rule of Law as a politico-legal benchmark to assess the appropriateness of sanctions is rather unique. However, the procedure resembles very much the ability of the Council of Europe to suspend any of its 47 members from the organisation where serious violations of the principles of rule of law and fundamental rights have occurred (Article 8 of the 1949 Statute of the Council of Europe).

2. The Court enforced the legality of the Regulation and separated it from previous mechanisms

Following the challenge launched by Hungary, the Court of Justice dismissed the country’s request and interpreted the regulation as an intention to protect the Union’s budget and not to punish breaches of the principles of Rule of Law (Hungary v Parliament and Council). As such, the legality of the act has been proven based on:

• The ability of the EU to defend the values enshrined in the treaties
• Linking the Rule of Law to trust, whereby through the principle of solidarity, Member States may only under full trust use the resources of the Union’s budget
• The fact that the conditionality mechanism falls under the financial rules of the Union’s budget implementation, where the European Union has power conferred by the treaties.
• The fact that the procedure under Article 7 TEU and the regulation pursue different aims and have different purposes.

3. Conditionality as a long-standing tool

Spending conditionalities have been common in the EU since 1994, with the introduction of the European Monetary Union and the adherence of economically unstable states to the Cohesion Fund that had to adopt economic plans and comply with EU budgetary deficit rules (Łacny, 2020). Moreover, ever since the 2008 financial crisis, Member States have been conditionally either fully or partly bailed out. Additionally, conditionality has been expanded and consolidated after each Multiannual Financial Framework (MFF) session, including fisheries, agricultural, cohesion and home affairs funds to cover Regional Development Funds, the European Social Fund and the Cohesion Fund as per Regulations 2021/1060 and 1303/2013.

Can Hungary afford to lose EU funds?

The RRF aims to stimulate structural reform and growth. The additional financial public investment has been increased under the Next Generation EU (NGEU), of which the RRF is the centrepiece and will be crucial for sustainable economic recovery (Watzka & Watt, 2020). The RRF will substantially affect the GDP of the economies most hard-hit by the pandemic, preventing further economic divergence (Watzka & Watt, 2020). Afman et al. (2021) also find that “the level of real annual GDP in the EU can peak around 1.5% higher than it would have without NGEU investments in 2024”. As previously mentioned, the RRF has been surrounded by political attention since the beginning, most controversially in Poland and Hungary. However, considering that the MFF and NGEU funds are expected to account for 3.3% of Hungary’s GDP in 2023 (Fitch Ratings, 2022), the loss of EU funds could put the economic growth and fiscal balance sheets at risk, having to cancel investment projects and seeking financing from market issuance.

Hungary is not in a great negotiation position. The ruling party, Fidesz, faced challenges after the pandemic, which have worsened due to the war in Ukraine. Inflation is at around 20%, fuel prices are increasing, and the Hungarian Forint has been losing value against the Euro (Végh, 2022). In other words, EU funding is a low-cost source of investment that Hungary cannot afford to lose (Fitch Ratings, 2022). Additionally, since the beginning of the year, the country has had waves of protests demanding the raise of teachers’ salaries who are currently underpaid. However, without the extra EU money, the government cannot allocate extra money to education and the operational programmes will have to be suspended (Kerner, 2022).

The European Commission proposed a suspension of €7.5 billion from cohesion policy funds and agreed on a package of anti-corruption reforms that the county will have to undertake. If Hungary fails to fulfil the agreement, it could lose about 70% of these funds (Végh, 2022). In mid-November 2022, the European Parliament called to freeze the funds after debating on the ineffectiveness of the financial management of the EU budget and the protection of the Union’s financial interests (Márton, 2022). On 30 November, a press release from the Commission stated that “Hungary failed to adequately implement central aspects of the necessary 17 remedial measures agreed under the general conditionality mechanism”. The Council had until 19 December to vote whether the funds would still be held back; however, an agreement was reached the week before. In exchange for Hungary lifting its veto on the 18-billion-euro aid package to Ukraine, only €6.3 billion of Cohesion funds will stay frozen while its recovery plan is approved (Tamma, 2022). Regardless, the Commission is still closely surveilling the rule of law in the country and expects Hungary to meet the agreed reforms to unlock all the remaining funds.

Hungary still has time to improve its rule of law. The government is still drawing on the 2014-2020 MFF, so the effect of not getting the funds would only be felt in a couple of years from now as the funds that could be suspended are under the 2021-2027 MFF period. Therefore, the impact on growth will only be observed later on. However, uncertainty over the upshots of the rule of law mechanism can have immediate implications, for example, adding inflationary pressures (Fitch Ratings, 2022). In the long term, unlocking the currently frozen EU funds is crucial for Hungary.

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