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Pakistan eurobond is a gift

THE Islamic Republic of Pakistan will float $500 million in five year eurobonds, the country's return to the international capital markets after the trauma of the post-nuclear test US sanctions had triggered off a cascade of credit downgrades and even a technical default when Islamabad froze all dollar bank accounts after massive capital flight in 1998.

It is ironic that Pakistan is raising new money only a month after it prepaid $ 1-1 billion of an Asian Development Bank loan. This suggests that the Pakistani government does not need the funds - after all, the central bank reserves of $12 billion cover no less than an entire year's imports.

Therefore, the only other explanation must be that the central bank wishes to re-establish the sovereign's name in the eurobond market, set a benchmark yield curve and possibly seek international validation of the Musharraf regime's structural reforms from Wall Street and the City of London. By conventional sovereign credit risk metrics, Pakistan should be rated at least two notches higher than B (Standard Poors) or B2 (Moodys). This rating, several notches below investment grade, reflects Pakistan's violent domestic ethnic politics and the quantum increase in geopolitical since 9/11, Islamabad's abandonment of the Taleban club for the Paris Club in one of history's major overnight policy U-turns, and the confrontation with India over Kashmir. Even if the diplomatic rapprochement between Pakistan and India after Vajpayee's recent visit to Islamabad for the Saarc summit reduces the risk of another Kargil on the Line of Control, the situation in Afghanistan is still fluid and President Musharraf's pro-American moderate policies are bitterly resented.

The Musharraf regime has proven the most successful macroeconomic managers in the history of Pakistan. Pakistan's inflation has plunged, the fiscal deficit has fallen from 7.5 per cent of GDP in the Nawaz Sharif era to 4.5 per cent now. No wonder interest rates in Pakistan have fallen by a phenomenal 700 basis points, thus acting as a catalyst for a powerful bull market that has taken the Karachi Stock Exchange from 1200 in October 2001 to 4800 now, a phenomenal four fold increase!. The dollars depreciation in the foreign exchange market, $ 4 billion in worker remittances after the crackdown of hawala and reverse capital flight after 9/11 from overseas Pakistani's led to an unprecedented rise in the rupee against the greenback. After a decade of glacial or even negative progress, Pakistan's military regime has become one of the most committed agents of privatisation in the Islamic world. No less than 80 per cent of banking assets are in the hands of private shareholders - United Bank was sold to an Abu Dhabi consortium, Habib Bank was sold to the Aga Khan Fund.

Pakistan has had a dramatic turnaround in the balance of payments since 2001 - its current account surplus of $ 4 billion is impressive, thanks to the surge in private capital inflows.

Pakistan's eurobond has miniscule default risk as long as the country is the Bush White House's partner against terror and the darling of the IMF, the Paris Club and the World Bank.

Interest payment on the external debt have fallen due to debit rescheduling and concessional finances and assistance from strategic neighbours such as Saudi Arabia. There is no doubt that Pakistan is a classic sovereign credit turn around story.

The problem with its new eurobonds is not Islamabad's macroeconomic track record but the razor twin credit spreads for non-investment grade 'B' credits in the emerging debt market at a time when the world is poised on the brink of a Fed credit tightening - after all, the last time the Fed tightened big time in 1994, Mexico went bullistic.

Emerging market sovereign credit spreads widen at once when the American central bank takes away its money pump-leverage, capital flight, hedge funds and global politics ensures that emerging markets sell off are, life in medieval Europe, nasty, medieval and short!. The fate of Pakistan's eurobond may be hostage to events in Washington, Moscow or horror of horrors - Caracas and Rio!

The Pakistan eurobond will be priced at 6.8 per cent yield in the London market. This is extremely cheap. Like Lebanon in 1994, Pakistanhas deliberately priced the issue cheap. The deal will be over subscribed.

I believe the bonds trade at a premium, as high as 108-112. What a gift, what a flip!

The author is : EVP of Eastern Trust LLC., Dubai email:eastrust @emirates.net.ae