(Bloomberg) -- Hungarian Prime Minister Viktor Orban’s government is pushing back against growing criticism over fiscal management that investors say may push the recession-hit economy into a negative spiral.

Finance Minister Mihaly Varga insisted the country’s plans are on track after the European Commission pointed this week to “weaknesses in budget planning and execution” and “ad hoc” spending it said was making a bad situation worse.

But missed deficit targets, reduced tax income and overspending have created a fiscal hole in the ballpark of $3 billion, said Viktor Zsiday, a portfolio manager at Hold Asset Management in Budapest.

“Hungary is in a vulnerable position in terms of financing,” he said. 

Concerns about the deteriorating fiscal position have started to weigh on Hungary’s bonds, which have been among the European Union’s best performers this year. While high nominal interest rates have attracted inflows and been supportive of the currency, Hungary’s 10-year yield is heading for its first monthly increase in three, rising about 26 basis points to 8.07% as of Friday.

“Investors are lured in by high rates, but most of them are close to the exit and could leave at any moment if bad news would hit, for example about the state of the budget,” Zsiday said.

Hungary “disputes” the European Union’s assessment of its budget management, Varga, the finance minister, said at a government briefing on Thursday. He also rejected a recommendation to cut lavish energy subsidies.

“We’re on track to hopefully reduce the budget deficit to below 3%” of gross domestic product next year, he said. “I wouldn’t call this a structural problem.”

The budget racked up a record shortfall for the first four months of 2023, and faith in the government’s ability to deliver on its pledges is waning. Even the Fiscal Council, a state body responsible for advising on public finances, expressed doubt about next year’s targets.

The budget is “so stretched that any negative developments would require its overhaul,” Fiscal Council Chairman Arpad Kovacs told state radio on Friday.

Hungary has suffered more than any other EU member from Europe’s cost-of-living crisis, as rising food and fuel costs helped drive inflation to more than 25% earlier this year, the highest in the bloc. Orban responded to the inflation surge by capping food and fuel prices and subsidizing utility bills. 

While the fuel price caps have since been phased out, discretionary spending has undermined fiscal consolidation, including the purchase of Vodafone Plc’s Hungarian business for $1.9 billion, a stake now majority-controlled by a company close to Orban.

Until recently, investor attention was mainly on the central bank’s key interest rate, the highest in the EU. At 18% until a one percentage-point cut this week, it drew in so-called hot money to Hungary while supporting the forint, which has gained 7.3% against the euro this year. 

But the high borrowing costs also helped deepen a recession that the government only expects to exit in third quarter. Tax revenue has plunged following a drop in consumption, and surging debt maintenance costs have caused a spike in expenditure. 

On top of that, the EU has frozen more than €30 billion ($32 billion) in grants and loans over corruption and rule-of-law concerns, adding to the fiscal strain. Earlier this month, the government raised its deficit targets for 2024 and 2025, just months after abandoning its goal for this year and missing last year’s.

“The extent of fiscal deterioration varies greatly among emerging markets, and Hungary is one of the worst culprits,” said Eimear Daly, a strategist at NatWest Markets. “I do think there is a risk that in the medium term, market focus shifts from monetary policy to fiscal policy.”

--With assistance from Krystof Chamonikolas.

(Updates markets, investor comments from third paragraph.)

©2023 Bloomberg L.P.