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* Budget will make new link to democratic values -officials
* EU wields tools to curb illiberal turn in Hungary, Poland
* Brussels seeks to mend rift while cracking economic whip
* Longer-term, though, populist trends remain a worry
By Alastair Macdonald
BRUSSELS, April 26 (Reuters) - The European Union will deploy a new financial weapon next week to try to rein in what Brussels sees as illiberal nationalism rising in the east of the bloc and threatening its democratic foundations.
A big electoral triumph on April 8 for Victor Orban, the Hungarian leader EU chiefs call “The Viktator”, and a battle to save the independence of courts in Poland have sounded alarm bells about the Union’s future when Britain leaves next year.
President Jean-Claude Juncker’s European Commission, backed by Germany, France and the EU’s other wealthy paymasters, will unveil proposals on Wednesday as part of the 2021-2027 budget that will tie funding, on which poorer eastern countries rely, to respect for the rule of law, EU officials told Reuters.
“Conditionality will be there,” one senior source said. A second said the budget pressure would be a “game-changer”.
“We have leaders flirting with another set of values,” said a third, referring to Orban’s call for “illiberal democracy” and his attacks on an open refugee policy which he says is promoted by Brussels officials set on imposing a new “empire” on Hungary.
“This is much more of a threat to Europe than Brexit.”
Budget details are still being hammered out and will be subject to arduous negotiations. But net EU spending accounts for more than 4 percent of public expenditure in Poland and over 7 percent in Hungary, and this is a factor in solid public support for EU membership in the two ex-communist states.
Under the proposals, funds could be withheld from countries which fail to abide by treaty obligations to respect the rule of law, such as by having independent courts.
The Commission believes it has a range of tools to clip the wings of its critics. Juncker’s goal, people familiar with his thinking say, is to heal an east-west rift before he steps down in 18 months and to bequeath a Union that is reshaping itself after losing one of its Big Three powers.
That dictates a softly softly approach which leaves critics of Orban and Poland’s dominant politician, Jaroslaw Kaczynski, less than satisfied.
EU officials expect Poland to back down enough next month on reforms of its judiciary to avoid the Commission having to follow through on a threat to try to suspend its EU voting rights — a compromise the EU executive believes will have been achieved through fear of penalties in the upcoming EU budget.
Tensions with eastern states could also be defused by tough EU action to keep out irregular migrants, by a prospective compromise on sharing out the task of looking after refugees and by efforts to deal with complaints from former Soviet-bloc countries that they are treated as second-class citizens.
“East to west: Europe must breathe with both lungs. Otherwise our continent will struggle for air,” Juncker said in September as he laid out policies for the rest of his mandate in what one aide described as “a love letter to eastern Europe”.
“We will work hard to keep them hooked in to the system,” said another. “With the right carrots — and sticks.”
The Commission faces a test of wills with Orban. EU officials expect him to step up challenges to Brussels but say legal sanctions have forced him to back away from some actions and voice confidence that they can do so again.
Orban has backed down after losing cases to the Commission in the European Court of Justice, including on a move to remove senior judges and a data privacy supervisor. He also accepted an ECJ rejection of his attempts to overturn a Union policy that would oblige member states to take in a share of asylum-seekers.
The executive expects to win cases, known as infringements, to block new Hungarian laws aimed at curbing funding from abroad, notably by Hungarian-American financier George Soros, of a university and of liberal non-government organisations.
The European Parliament has urged the Commission to launch moves to suspend Hungary. Opponents say more should be done to stop misuse of EU funds by businesses close to Orban.
Benedek Javor, a Hungarian opposition member of the European Parliament, says the Commission has been “too soft” and checks on the executive’s ability to step into national politics mean the system is “artificially paralysed”.
Countries face a high bar to prove democratic credentials to join the EU but sitting members face less scrutiny, he said.
Poland will be the fifth biggest state in the post-Brexit EU and is, Commission officials say, more of a worry — the “test case” for curbing intolerant leaders.
But Poland’s ruling party, under Kaczynski, appears more responsive. As the EU began preliminaries to suspension in December, Kaczynski brought in a new prime minister who has engaged more actively in talks with Brussels to avoid censure.
EU officials say a deal under which Warsaw waters down bills on the appointment of judges could be struck next month, before budget talks start.
Brussels may not be fully satisfied but a compromise would send a signal to governments and end a row in the EU. As Orban has said Hungary would veto suspension of Polish membership, launching Article 7 procedures would be of limited use anyway.
Other eastern governments have also been discreetly lobbying Warsaw to step back from confrontation. “We’re telling them ‘look, you’re endangering our budget funds too’,” said a senior diplomat from a country also heavily dependent on EU cash.
Faced with the tricky task of defining when elected leaders are damaging democracy, the Commission has focused on economic regulation and frames moves to give governments influence over courts as undermining the EU’s open internal market.
Orban’s attacks on Soros’s projects face infringement cases citing freedoms to move money across frontiers or to open a business.
The Court of Justice is also sharpening its tools. A recent ruling has updated EU jurisprudence on judicial independence and it is considering an Irish judge’s refusal to extradite a suspect to Poland over concerns about fair trials there.
There is also a growing willingness among the EU’s political leadership, notably among governments in many other member states, to take their peers to task over the summit table.
“Where once we spoke about fish and finance,” the EU official said. “We are now speaking about fundamental values.” (Additional reporting by Noah Barkin; Editing by Timothy Heritage)