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The European Union's executive body called for cutting 7.5 billion euros in funding for Hungary, due to concerns about corruption and backsliding over democracy.
The recommendation, made Sunday, was the first to be made by the EU under new policies aimed at protecting the rule of law in the 27-nation bloc.
Hungary has until November 19 to address the concerns, EU Budget Commissioner Johannes Hahn said.
"It's about breaches of the rule of law compromising the use and management of EU funds," Hahn said in Brussels. "We cannot conclude that the EU budget is sufficiently protected."
He said the money would come from "cohesion funds" granted to Hungary, which is one of the biggest parts of the bloc's budget. The money helps countries to bring their economies and infrastructure to meet EU standards.
Any action to suspend Hungary's funds must be approved by the bloc's 27 member countries. Under EU rules, this requires what's called a "qualified majority," which amounts to 55 percent of the member states representing at least 65 percent of the total EU population.
Not long after the EU announcement, Tibor Navracsics, Hungary's minister in charge of EU negotiations, said there was "a good chance" his government would be able to sign an agreement over the use of European funds by the end of the year.
Last week, Hungarian officials reacted angrily when the European Parliament approved a resolution saying the country was not a "full democracy." Fidesz, the ruling party that is controlled by Prime Minister Viktor Orban, said "the European Parliament is attacking Hungary again."
But Orban's chief of staff, Gergely Gulyas, said that Budapest would establish an anti-corruption department and a working group with nongovernmental organizations to oversee spending of the EU funds.
"The government has either accepted the requests of the European Commission, or in the areas where we could not accept them, we have managed to reach a compromise that is satisfactory to both parties," Gulyas told reporters on September 17.
Orban, who was reelected for a fourth consecutive term in April, has clashed often with the bloc over issues such as judicial independence, LGBT rights, and media, academic, and religious freedoms.
Information from Reuters and AP was used in this report.