KARACHI, Feb 17: Pakistan will examine the sustainability of the US interest rates before it swaps the fixed interest rate of its $500 million eurobonds with the floating rates to be quoted by foreign banks interested in the deal.

"We will examine this (the sustainability of the US rates) and other issues before we go for it," said a senior official of the ministry of finance reached by Dawn over telephone in Islamabad.

The official involved in the launch of $500 million eurobonds last week said some leading foreign banks had shown interest in interest rate swap but declined to name them.

Finance Minister Shaukat Aziz had said the other day that Pakistan could swap the fixed interest rate of 6.75 per cent on its eurobonds with the floating rates. But he had made it clear that the yield on the bonds was reasonably low - and that the interest rate swap could be made to bring it further down "to silence the criticism". He said that bids would be called from international financial houses and banks within two weeks.

Sources at the ministry of finance explained to Dawn that the most critical issue concerning the proposed swap of the interest rate is the sustainability of the US interest rates currently at 45-year low.

When a country swaps the fixed interest rate of its eurobonds with the floating rates quoted by an international bank it actually lends these bonds to that bank for six months.

The bank in question pays to it the fixed interest rate. Then that country borrows these bonds from the banks in question at a floating rate - the US treasury rate or LIBOR (London inter-bank offered rate) serving as the benchmark.

Keeping this in mind consider this scenario: if Pakistan goes for interest rate swap it will lend $500 million eurobonds to an international bank or financial house or a group of them at 6.75 per cent for six months.

Then it would borrow these bonds at a floating rate determined by that bank or financial house or their group.

This floating rate would be a bit higher than the six-month US Treasury rate or six-month LIBOR plus Pakistan's country risk premium. Since the bonds were launched with its yield fixed at a five-year US Treasury plus 370 basis points, its six-month floating rate would most likely be six-month US Treasury rate i.e. one per cent plus 370bps i.e. 4.70 per cent.

The bank with which the interest rate swap would be made will also load say five basis points as its fee, pushing this figure up to 4.75 per cent.

That is why the finance minister said that the proposed interest rate swap would reduce the effective yield on the eurobonds by two percentage points i.e. 6.75pc minus 4.75pc. "But this scenario can change with an increase in the short- term interest rates in the US," said treasurer of a foreign bank.

That the US interest rates now at 45-year low have bottomed out - and seem set to rise in near future is a common knowledge for all in the international financial sector.

Once the US short- term rates start rising the benefit derived from the swap of fixed interest rate of Pakistan eurobonds with the floating rates would begin to decline.

"This benefit (currently estimated around two percentage points) may even vanish or turn negative before the maturity of the bonds in 2009," the banker said. Officials at the ministry of finance say they are closely working on this and other related issues.

"There are so many products (developed by the interested banks and financial houses to swap fixed interest rate of eurobonds with their own floating rates). We will choose the best among them," said one senior official of the ministry.

But bankers well-versed with the mechanism of interest rate swaps say such swaps suit the corporates and the banks - and not the governments. "The corporates and banks have the expertise and the systems in place to quickly change positions keeping in view the changing interest rate scenario," said a foreign bank treasurer. "But the governments - particularly those of the developing countries like Pakistan - lack such expertise. Besides, they are slow in decision making whereas banks and corporates respond to changed market conditions almost instantly."