Hungary faces losing EU cohesion funds after the European Commission ruled that its government had not taken effective action to ensure that its budget is sustainable.

EU Commission vice-president Olli Rehn said the situation was regrettable, but the Brussels was obliged to apply rules on excessive deficits to ensure equal treatment.

Four other countries under review - Belgium, Cyprus, Malta and Poland - were viewed as having taken corrective action and so will not face penalties.

The Commission has been given enhanced powers, under what are known as "six-pack" regulations, to ensure both EU and euro zone countries keep their deficits below 3% of GDP.

At a news conference, Mr Rehn said that the Hungarian government had planned to take one-off measures - such as transferring private pension funds - to tackle its budgetary difficulties.

But the Commission said this would continue to leave the budget on an unsustainable path, and therefore could not be considered to be a sustainable correction.

The Commission's recommendation of the imposition of financial sanctions on Hungary will now be considered by EU finance ministers at a meeting in Brussels on January 23.

EU to demand action on constitution

An EU source has said the Commission will demand Hungary row back on controversial changes to its constitution or face possible legal action in warnings to be delivered next week.

The source said the European Commission was readying three letters of warning to the Hungarian government regarding the independence of its central bank, judiciary and data protection services.

"Three letters of warning are in preparation" for delivery next week, the first step in potential infringement proceedings against Budapest, the source said.

Prime Minister Viktor Orban has come under international and domestic fire over constitutional refoms adopted by his parliamentary majority late December.

Critics say they remove checks and balances on the power of the government and increase Orban's control over the judiciary and central bank, while skewering the electoral system in his party's favour and curbing freedom of the press.

A request by the economically troubled nation for a bail-out by the European Union and IMF worth €15-20 billion is in limbo after talks were suspended last month over EU concerns about its new bank law.