Hungarian Prime Minister Viktor Orban says his country's close relations with Russia are "common sense, reality-based policy". In that same spirit of realpolitik, when his government revealed in 2014 that it had struck an agreement for Kremlin funding of a project to expand its sole nuclear power station, Orban's finance minister justified the move as offering “the cheapest deal”.

However, that may no longer be the case, as Hungary eyes lowered borrowing costs on international markets. As an added bonus, ditching the Russian financing may help smooth over some of the concerns in Brussels over the project.

Market analysts, as well as the European Commission, have long questioned the fiscal wisdom and legality of the deal, which hands construction of two new nuclear reactors at the Paks plant to Russian state nuclear agency Rosatom. More recently, comments from Moscow officials have raised doubt over Russia’s willingness to live up to its side of the bargain to fund 80% of the project via a €10bn credit line, which Hungary has said it plans to tap if and when the European Commission authorises the deal.

Beset by western sanctions, recession and a collapsed ruble, Russia's fiscal position has been crumbling since the deal with Hungary was signed, and Moscow has already pulled back on other financing deals on nuclear exports. More recently, Deputy Finance Minister Sergey Storchak announced in May that “Russia has no money to finance foreign loans”. The speculation only grew when on a visit to Budapest, Foreign Minister Sergey Lavrov insisted “Russo-Hungarian relations are not dependent on Paks II”. 

That comment came a few days after Janos Lazar, head of the prime minister's office, told parliament that Hungary could seek a different route to find the capital to run the project. “Hungary’s money market position has greatly improved lately and therefore Hungary is ready and able in the near future to replace the loan with capital obtained on the open financial market,” the powerful official claimed. 

Cheaper

Indeed, analysts question whether the government now needs the credit line at all. Hungary's massive current account surpluses in recent years, as well as Fitch's upgrade of the country to investment grade, have made borrowing a lot cheaper for the sovereign. 

“If the government sticks to a budget deficit well short of 3% of GDP over the years to come - as is likely - the additional financing need related to the Paks project will be at least partly offset by counteracting measures in the budget,” Janos Samu of Concorde, Hungary’s biggest brokerage, suggests to bne IntelliNews.

Given the tightened borrowing costs available to Hungary today compared with 2014, the market would probably offer better value than the Kremlin, the economist adds. “A 15-year euro-denominated government bond yield would be around 3.5%," he points out; "the Russian credit bears a 4.8% interest rate."  

Some suggest rather than a Russian retreat, it is Hungary that is seeking to wriggle out of the deal. “They are opening a possible exit strategy,” says a senior executive at a major Hungarian energy company, who spoke on condition of anonymity. "Cancellation of the Paks II credit line would cost Hungary 3 or 4 percent - or €300-400mn - of the total budget. This is not negligible given the state of the economy,” the official adds. 

However, replacing the Russian credit line with a eurobond isn’t the only option available to Hungary. The National Debt Management Agency (AKK) suggested last month that it could issue domestic debt to cover the tab, which given the government's exhaustive efforts over recent years to reduce external debt – a cornerstone of the Fitch upgrade – would fit with the longer term fiscal strategy. Budapest could also seek to renegotiate terms with Russia, AKK added.

Compromise

However, it's not just the funding of Paks II that is a challenge. The European Commission has spent a long time studying the deal that handed Russia the contract.

Brussels has already launched an infringement procedure regarding the public procurement process, and is also running a probe into whether the project involves illegal state aid. The commission said in a statement last November that it will "assess whether a private investor would have financed the project on similar terms”. That implies the procedure concerns the whole €12bn set to be sunk into Paks II. 

A Greenpeace-commissioned report released on May 31 said the project is "economically uncompetitive" and unviable without a state subsidy. It also called Hungary's estimate that average capacity usage of the new blocks will equal 90.7% “an optimistic assumption”.

Nevertheless, Hungary was bullish on finding a resolution to the stand-off after talks with EU Competition Commissioner Margrethe Vestager on May 30. “We will work until the start of the summer break to wind up procedures related to the Paks upgrade,” Lazar said after the meeting.

According to Benedek Javor, a Hungarian MEP for the green Dialogue for Hungary party who says he has seen the Paks II agreement, Brussels is still waiting for documents related to the public procurement charge that would prove Hungary had to give the project to the Russians because of the technical demands. Budapest has claimed that as Paks I is Russian built, the extension must be also. However, the green MEP insists Paks II is essentially a completely new plant.

Meanwhile, citing inside sources, he hints Brussels is ready to compromise on the state aid probe. "The commission wants Hungary to acknowledge that there is state aid in the project,' Javor states, claiming the EU executive will then allow it to ride should Budapest agree to a compromise deal. 

The energy executive backs that up. “Hungary could formally accept conditions and, for example, lower the state contribution or involve French, Japanese or German firms," he suggests. "Colleagues in Brussels are saying that the European Commission's position is: ‘okay you can give state aid and ruin your economy with Paks II, but we will not contribute to other parts of your energy sector'."

However, in the event of a Commission ruling that Paks constitutes state aid, it is clear that Austria will immediately head for the European Court, just as it did over Hinckley Point in the UK. Vehemently anti-nuclear, Vienna will grab any advantage it can to try to block 2,000MW of extra capacity close to its border.