THE PARIS Club is meeting on December 12 to consider debt relief in order to make Pakistan’s external sector viable with economic growth.

To quote the Governor of the State Bank Dr. Ishrat Husain, Pakistan is currently spending $1.6 billion a year on servicing bilateral debt.” We want to reduce it to $400-500 million. It must be a permanent debt reduction.”

In January 2001, for the second time,the Paris Club, other bilateral and commercial creditors agreed to reschedule debts worth about $1.8 billion which just accounted for 35 per cent of the total debt service obligations. On the $12 billion bilateral debt, Pakistan repaid $432 million as principal and $ 934 as interest on the liability.

Dr. Ishrat Husain reportedly said that Pakistan wants interest to be stretched over a longer period, along with the provision of grace period. It would continue to pay the principal amount on a yearly basis.

Sources in the State Bank indicate that debt relief will be provided on the basis of Net Present Value(NPV) of the current debt stock. The bilateral donors are expected to reduce obligations, with reduction in NPV. The exercise is undertaken on the strength of economic policies.

Pakistan has revalued its stock of public and publicly guaranteed debts at current exchange rates. The problem arose as the multilateral disbursements and repayments were valued at current exchange rate but previous debt stocks had not been revalued accordingly.

With creditors providing their numbers in several different currencies, an upward revision was made in the multilateral debt stock in fiscal 2000. The net valuation impact amounted to $101 million in fiscal 2001 with downward adjustment in case of Paris Club creditors and an upward revision in multilateral and other bilateral debt stocks.

The adjustment reduced the bilateral debt stock in case of Paris Club creditors by $580 million in 2001 as compared to fiscal 2000.

The Paris Club is expected to ensure that debt servicing re-profile is consistent with a country’s ability to service debts in the medium-term. It could help the country to regain access to international credit markets.

Of all the forms of external assistance meant to provide budgetary and balance of payments support, analysts consider debt re-profiling as” a most potent catalyst “for a meaningful change in the economic situation.

Re-profiling of debts will generate fiscal space unlike rescheduling where the government is obligated to continue to earmarking fiscal resources in local currency as if it were making the debt service payments in foreign currency.

The expectation in the capital market is that whatever the effective reduction in Pakistan’s debt stock and annual debt servicing as a result of Paris Club decision,the vulnerability of the external sector is likely to be reduced.

It is not yet clear whether the debt relief exercise will be applicable to the total stock of bilateral debt of $12 billion or just to a portion of it.

Islamabad is seeking substantial debt relief under the Naples terms.Unlike rescheduling, which is essentially the replacement of an existing loan obligation with another, financial analysts at ABN-AMRO say that “re-profiling entails a reduction in the stock of outstanding debt in net present value (NPV) terms-through a stretching out of the maturity of outstanding loan contracts.”

Depending on the terms applied, the reduction of NPV of the debt stock could be 67 per cent or even greater.Some officials reckon it could be about 80 per cent. Under the re-profiling, the interest rate on the outstanding loan amount, would be on concessional terms.

While rescheduling provides for lower repayments during a designated time-frame(the consolidated period), with payment schedule returning to normal at the end of one or two years, re-profiling will provide a more permanent reduction in the stream of payment flows by virtue of being both a stock as well as a flow operation, say financial analysts.

Financial analysts at Tauris Securities say that there are increasing indications that Pakistan will obtain rescheduling at Naples terms.Pakistan has been a recipient of debt rescheduling (FY2000 and FY2001 ) under Houston terms.

Under Naples terms, these analysts say, a country can obtain 67 per cent reduction in non-ODA (Official Development Assistance) credit i.e. non-concessional debt from the Paris Club. This debt reduction may be implemented in two ways: a) Debt reduction option:67 per cent of the eligible debt is cancelled and the outstanding amount is rescheduled at the “appropriate market rate” over a 23-year repayment period.

b) Debt service reduction option: the eligible debt is rescheduled at a “reduced interest rate” over a 33-year period. Working on the assumption that Naples terms are applied, Pakistan’s debt is likely to be rescheduled under the second option that entails a a reduction in annual debt servicing cost. Of the $12 billion Paris Club debt, approximately 33 per cent is non-ODA credit.

Over the last two years, Pakistan has received debt rescheduling of about $900-1000million. Hence to leave the country no worse off compared to last year, say financial analysts, the annual debt serving cost would need to be reduced by as much as $900-1000 million as a result of rescheduling under Naples terms.

Analysts at the Taurus Security think “the net cash flow will be minimal in the short term.” The underlying object of the Naples terms is to help heavily indebted countries climb out of the debt trap. These countries, Pakistan being one of them, usually need to resort to expensive short-term commercial borrowing to fulfil annual debt-servicing obligations, thus becoming entailed in a serious debt trap. Debt rescheduling under the Houston terms did not help this situation as adjustments in the payment schedule under those terms left the NPV of debt unchanged.

The Naples terms offers an exit strategy through a reduction in the NPV of debt. This is a longer term strategy as opposed to short-term breathing space provided by the Houston terms.

As far as the short-term impact of Naples terms goes, financial analysts say,this will not be too different from the Houston terms as the reduction in debt servicing obligations for FY 02 are likely to be adjusted against new disbursements budgeted for this year.

To sum up, these analysts say, that under the Naples’ terms, instead of rescheduling and capitalizing deferred interest payments, a certain portion of these payments would be written off, thereby reducing their overall burden and its future growth rate.