Hungarian Prime Minister Viktor Orban tried to move closer to a deal with the European Commission on Tuesday to rework laws critics say undermine democracy so he can revive stalled international aid talks.

But Orban's deputy tempered expectations of an agreement and

revealed a potential point of conflict between Budapest and the Commission, which has threatened legal action if Hungary does not change laws on the central bank, courts and data protection that critics say undermine democracy.

European Union finance ministers also opened the way on Tuesday for the bloc to freeze cohesion funds to Budapest, saying unorthodox decisions that Orban has used to cut the budget deficit had not brought it below the bloc's ceiling in a sustainable way.

Orban's efforts to centralise power and stack Hungarian state bodies with party loyalists have drawn criticism from Brussels and Washington, which fear they stifle democratic freedoms in the ex-communist country of 10 million.

He has lost much of his support at home, while the economy is heading for recession and investors' loss of confidence has pushed borrowing costs to above 9 percent. Analysts say Orban needs an aid deal to maintain access to the markets.

He will meet Commission President Jose Manuel Barroso on Tuesday to present a timetable for legal changes.

However, Deputy Prime Minister Tibor Navracsics said the aim of the meeting was not necessarily to clinch a deal that would give a green light for aid talks with the EU and IMF to resume.

I do not know if either the prime minister or the president of the Commission have the ambition to strike an agreement today. The issues at stake are just not that pressing, he told public radio.

A $13 billion (8 billion pound) private pension grab produced a rare fiscal surplus last year, buying Hungary some time before it must borrow 5 billion euros to fund repayments to bondholders and to the EU and IMF for an earlier loan.

But the economic outlook is grim. The European Bank for Reconstruction and Development cut its forecast for Hungary's economy on Tuesday to a 1.5 percent contraction in 2012, its weakest outlook in emerging Europe.

Confounding market expectations, the central bank left interest rates on hold at 7 percent at a meeting on Tuesday.

Analysts in a Reuters poll had predicted a half point hike after the bank made two such increases since November to staunch investor flight from Hungarian assets. The unexpected hold move knocked the forint half a percent lower versus the euro.


Orban in the past pledged to resist outside pressure from parties like the IMF and EU and take Hungary on its own course.

But then rating agencies cut Budapest's debt to junk and the Commission began infringement procedures. After investors fled the forint, driving it to a record low against the euro and pushing bond yields above a ruinous 11 percent, Orban promised to reverse some policies.

It was a major political climbdown for the prime minister who swept to power in 2010 with the strongest political mandate in Hungary's post-communist history although analysts and EU leaders are waiting him to fulfil the pledge.

We trust that what Prime Minister Orban promised us, namely to comply with EU legislation, will be true, Commission spokesman Cezary Lewanowicz said in Brussels ahead of Orban's meeting with Barroso.

Orban's overtures to the EU and IMF have generally boosted market sentiment, lifting the forint a cumulative 5.5 percent higher since it hit an all time low of 324.2 per euro on January 5.

Given the government has until February 17 to respond to the European Court of Justice's infringement procedures, Orban will continue to stall, even using his meeting today to get a sense of where Barroso's limits lie, think tank Eurasia Group said in a research note.

A top government official said on Monday that Hungary could have a new funding deal in place worth around 17-20 billion euros by March or April. Points of conflict remain, however.

Navracsics said the government disagreed with a Commission demand that Hungary reverse a law lowering the retirement age of judges from 70 to 62, a move Brussels says infringes on judiciary independence.

Another issue is Hungary's budget. EU finance ministers endorsed a view from the Commission that Hungary had not done enough to bring the gap below the EU's 3 percent of gross domestic product ceiling in a sustainable way.

While the Hungarian deficit is set to hit that target, the Commission believes it is only due to one-off measures and the shortfall will grow again in 2013.

From the moment the ministers approve the Commission's assessment that Hungary has not taken effective action, the Commission is free to decide to suspend up to 100 percent of cohesion funds for Hungary from 2013, an EU official said.

Hungary will have until the end of the year to act to change the Commission's mind.

(Writing by Gergely Szakacs and Michael Winfrey; Additional reporting by Marton Dunai; Editing by Anna Willard and Hugh Lawson)