The European Commission is planning to block almost $1bn in funds for Bulgaria as a penalty for failing to tackle corruption and organised crime.
A report seen by the BBC warns that millions worth of aid could be lost unless the authorities act decisively.
Bulgaria's chances of joining the Schengen area are also at risk.
Bulgaria and its neighbour Romania are subject to special monitoring because they did not fully comply with EU standards when they joined the bloc.
The Commission's nine-page report, due to be published next week, is possibly the most scathing written by the EU executive about a member state.
It concludes that Bulgaria "has to make the commitment to cleanse its administration and ensure that the generous support it receives from the EU actually reaches its citizens and is not siphoned off by corrupt officials, operating together with organised crime".
Mafia killings
The EU has already frozen hundreds of millions worth of aid destined for Bulgaria's roads and agriculture.
Now it is planning to withdraw the right of two agencies to handle EU funds worth almost $1bn (610 million euros).
The report warns that almost $400m (250 million euros) could be lost unless things improve by November.
Billions more in future funding are also at risk, as are Bulgaria's chances of joining the Schengen border-free zone anytime soon.
The European Commission will also raise concerns about the persistent failure to solve any of the 150 mafia killings recorded in Bulgaria since the fall of communism.
In a separate report, Romania is also expected to face strong criticism, especially over the parliament's delay of corruption inquiries involving a former prime minister and other top officials, but the European Commission will stop short of sanctions.
Yet both countries will continue to be watched very closely and officials say the measures planned against Bulgaria should serve as a warning to others, both inside the EU and those hoping to join it.
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BBC