French Soldiers Accused of Sexual Assault in Africa

Chile’s President Vows to Rewrite Constitution

ASIA

Saigon 40 Years Later: Entrepreneurs Return

EUROPE FILE

Spain and Portugal Can Cope With Grexit

Quake Aftermath Widens Nepal’s Political Divisions

FBI Played Role in Ransom for U.S. Hostage

Afghan Forces Press Counter-Offensive Against Taliban

Young Saudi Royals Rise in Turbulent Times

Abe Presses Case for Trade Pact

Europe Credit Squeeze Ending

Iran: Ship Seized Over Debts

French Soldiers Accused of Sexual Assault in Africa

Chile’s President Vows to Rewrite Constitution

ASIA

Saigon 40 Years Later: Entrepreneurs Return

EUROPE FILE

Spain and Portugal Can Cope With Grexit

Quake Aftermath Widens Nepal’s Political Divisions

FBI Played Role in Ransom for U.S. Hostage

Afghan Forces Press Counter-Offensive Against Taliban

Young Saudi Royals Rise in Turbulent Times

Abe Presses Case for Trade Pact

Europe Credit Squeeze Ending

Spain and Portugal Can Cope With Grexit

Both countries are at risk from a Greek eurozone exit, but they have confidence their economies can withstand the shock

SIMON NIXON

April 29, 2015 4:55 p.m. ET

0 COMMENTS

If anyone was going to blink over Greece, one might think it would be Spain or Portugal—the two countries widely considered most at risk if Greece leaves the eurozone. Indeed, both saw a slight rise in their borrowing costs last week at a particularly bleak moment in Greece’s negotiations with other eurozone members. And Goldman Sachs warned in an eye-catching report this week that if Greece does exit the euro, Spain’s borrowing costs could rise to four percentage points above Germany’s, compared with a spread of one percentage point now.

Greece has largely based its brinkmanship is based on an assumption that the eurozone will ultimately capitulate to its demands to prevent chaos spreading across the currency bloc.

Moody’s Cuts Ratings on Greece

Yet it is striking that Spain and Portugal aren’t clamoring for a eurozone capitulation but are among the hardest of hard-liners in demanding Greece respect the conditions of its loan agreements. This isn’t just a negotiating tactic. Publicly, Madrid and Lisbon say they hope Greece will remain in the eurozone, but senior figures in Madrid and Lisbon are privately clear that they believe it would be better for Greece to leave than to risk the chaos of tearing up eurozone rules.

Of course, this partly reflects domestic politics: Madrid and Lisbon are acutely aware that conceding too much to Athens would embolden their own radical leftist opposition. But it also reflects a growing confidence that the Spanish and Portuguese economies—thanks to their own efforts and those of the eurozone—are now resilient enough to withstand the shock.

This confidence looks well-placed. The turnaround in the Spanish economy since the summer of 2013 has been remarkable. This week, Madrid raised its forecast for growth this year to 2.9% from 2.4%—and officials are optimistic it will turn out to be well above 3%, twice the likely eurozone average.

PREVIOUS COLUMNS

U.K.’s Cameron Can’t Get a Break(April 27)
Greek Bailout Standoff Tests IMF(April 23)
Europe Braces for Messy Greek Endgame (April 20)
QE Is Working Better Than ECB Dared Hope (April 16)
Europe Slow to Adopt Accounting Standard (April13)
A European Bypass for the U.K. Electorate (April 9)
Eurozone Recovery Still Leaves Furrow on German Brows (April 2)
Greece’s Fate Is in Its Own Hands (March 29)
The Greek Rescue Needs to Be Long-Term (March 26)
Osborne at Height of Monetary Activism (March 19)
Greek Crisis Tests ECB’s Credibility(March 15)
Germany Urges Greece to Honor Pledges (March 13)
Clock Is Ticking Down on a Greek Solution (March 11)
U.K. Election Promises Bumpy Ride for Investors (March 8)
Greece Not Such a Drag for Eurozone (March 1)
Tsipras Can Expect More Humble Pie (Feb. 22)

The economy created half a million jobs last year and is expected to create about the same again this year as the combination of low oil prices, a weak euro and falling interest rates drives a rapid recovery in business and household spending. House prices have stabilized, new loans to small and medium-size companies are soaring, and the latest European Commission survey shows economic sentiment at the highest level since 2001.

Portugal’s turnaround has been less spectacular but has also defied expectations. Lisbon expects growth to reach 1.6% this year, rising to 2% in 2016 and 2.4% thereafter. Unemployment has also been falling fast, down from a peak of 17.5% in 2013 to 13.3%.

At the same time, the budget deficit is shrinking faster than expected, helped in part by a successful reform of the tax system. This year, the government is targeting a deficit of just 2.7%; only a year ago, the International Monetary Fund was forecasting that this year’s budget deficit would be 5%.

True, both the Spanish and Portuguese economies still suffer from significant vulnerabilities. In Spain, the major weakness is the very high stock of financial assets held by international investors, equivalent to 96% of gross domestic product, a legacy of the tide of money that flowed into the country during the bubble years.

Although Spain is now running a small current-account surplus, which means it is no longer adding to this stock of foreign liabilities, the country remains vulnerable to a sudden change in investor sentiment.

Portugal also has a a stock of debt problem, in this case the very high level of outstanding private-sector borrowing, which remains a drag on growth.

The deleveraging process has been held up by a weak insolvency regime and an inefficient judicial system that makes it hard to restructure bad debts. And despite overhauls over the past few years, growth is still being held back by an inflexible labor market and a rigid product and services market that keeps prices high and discourages competition.

The biggest risk in both countries is therefore political. Spain’s resilience depends on continuing to attract foreign capital while boosting its exports to reduce its reliance on foreign borrowing. Its challenge is to reassure investors over its public finances by getting its budget deficit down from a still-high 5.6% and continuing to pursue reforms to improve its export competitiveness. Portugal’s challenge is to raise its potential growth rate through continued supply-side reforms.

Until recently, the market was fearful that elections due later this year would blow both countries off course. But those fears are rapidly receding.

Call it the Syriza effect: The economic calamity that may be unfolding in Greece is undermining support for populist parties across Europe. Support for Podemos—Syriza’s sister party in Spain—has plunged. Polls now show a four-way tie in Spanish politics, with support surging for the new center-right, pro-business party Ciudadanos. As a result, Podemos’s chances of entering a coalition later this year are small and diminishing, says Antonio Roldan Mones of consultancy Eurasia Group.

Meanwhile in Portugal, support for the current coalition has drawn level with the opposition Socialists, who themselves have shifted toward the political center.

Of course, that still leaves the risk of financial-market contagion. Goldman Sachs appears to be more pessimistic than most economists and policy makers; after all, any contagion would be largely psychological since Spain and Portugal have minimal financial exposure to or economic links with Greece.

But as Goldman points out, the scale and duration of any volatility would depend on how the rest of the eurozone responds. If a Greek euro exit led to further eurozone integration, some in Madrid and Lisbon may consider that a price worth paying.

Write to Simon Nixon at simon.nixon@wsj.com