By Oana Lungescu
BBC European affairs correspondent, Brussels
The EU has urged Bulgaria to do more to tackle violent crime
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.
The commission's nine-page report, due to be published next week, is possibly the most scathing ever 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".
Bulgaria and its neighbour Romania are subject to special monitoring because they did not fully comply with EU standards when they joined the bloc.
Lack of will
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).
EU officials welcome recent changes, including the appointment of a respected diplomat, Meglena Plugchieva, as a deputy prime minister in charge of overseeing EU funds.
But the report suggests there is little political will elsewhere to clean up things.
"Despite the Commission's repeated requests for improvement of the management and control systems, within reasonable deadlines, the Bulgarian authorities... have not fully explained or clarified the situation surrounding the irregularities and have not taken all necessary steps to correct them," it says.
The draft report goes on to say, "high level corruption and organised crime exacerbates these problems of general weakness in administrative and judicial capacity... Urgent action is needed because deadlines for contracting some of the funds are approaching after which the funds will be lost to Bulgaria".
Almost $400m (250 million euros) could be lost unless things improve by November.
Bulgaria, the EU's poorest country, stands to receive $17bn in EU funds until 2011, and this is a serious warning that future funding is in jeopardy.
Costly projects to upgrade border controls are also under suspicion of fraud, raising fears about Bulgaria's chances of joining the Schengen border-free area any time soon.
Earlier this week, Bulgarian newspapers published leaks of another report by the EU's anti-fraud office into suspected irregularities in the spending of some $50m of farm funding.
The document alleges there is a political umbrella protecting corruption, saying there are "powerful forces in the Bulgarian government and/or other state institutions" who are not interested in punishing the corruption.
Bulgarian Prime Minister Sergei Stanishev dismissed the allegations.
But earlier this year, the powerful interior minister was forced to step down after revelations he had secretly met two alleged crime bosses and some of his officials were leaking confidential information to mafia suspects.
With a general election scheduled next year, the European Commission's report will only add to the troubles of Mr Stanishev's beleaguered government.
Pressure is mounting on Sergei Stanishev's administration
The opposition is preparing to table a motion of no confidence the day after the document is adopted is in Brussels.
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.
One EU official said that "Romania was marking time, while Bulgaria had gone backwards".
Diplomats say the strong language of the draft report may be watered down by Wednesday, when the 27 European Commissioners, including those from Bulgaria and Romania, are set to adopt it.
But the general feeling is that something must be done, and seen to be done, to maintain the credibility of the EU with its taxpayers.
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.