The Next Sovereign Defaults

Kyle Bass of Hayman Capital was on CNBC discussing the danger of growing public debts, particularly in Japan and Greece. Few months ago, Bass also warned about the risk in recent global debt bubble in the excellent letter to investors, The Cognitive Dissonance of it All.

Hayman Capital's preferred yardsticks for understanding sovereign debt are (1) sovereign debt to central government revenue and (2) interest expense as a percentage of central government revenue. Bass explains that while most studies uses GDP as the denominator in measuring and comparing ratios, revenue is more precise measure of a government's ability to pay off the debts. In the letter, they calculated the ratios using estimated data from various sources. Below, I replicated the same ratios using the public data from IMF [1].

In 2010, IMF estimates Japan debt / revenue at 700%, which is much lower than Hayman Capital's estimate at 1900%. Japan net debt / revenue ratio is at around 380% and allocates a modest 3.7% (compare with 15% for Greece) of government revenue on net interest payment. This is due to Japan's ability to finance most of its debt domestically at low cost. Japan looks terrible on the long-term but has yet to have a problem financing its debt. In anticipation of black swan event of a default, I believe hedge funds have overestimated Japan's sovereign debt issues in the short-run.

Italy's economy has not received unwelcoming attention from the market until recent S&P downgrade. But if you look at the data, Italy's high debt, low forecast growth and relatively high cost on debt are recipes for disaster [2]. Considering the complexity in correlation between countries in eurozone, a default in GIPS (Greece, Ireland, Portugal and Spain) might just send Italy to crisis mode. And as the third largest eurozone economy, Italy's debt might be too big for a bail out.

Updated: Economist's grim outlook on Italy

Government Debt / Revenue (2010)

Government Net Debt / Revenue (2010)

Government Net Interest Payment / Revenue (2010)

[1] World Economic Outlook Database, April 2011. 2010 data from Belgium, France, Ireland, Japan, Portugal, UK and US are estimates by IMF.

[2] Italy has debt / revenue of 256% and allocates more than 9% of its revenue financing debt.