Its been a while since I've done this but as I recall its a 2 step process.
1. Use the Parallels utility (??name) to resize the virtual disk file. This takes seemingly forever. It will expand the physical disk but not the partition.
2. Download the Linux system rescue disk (.iso file) at
http://www.sysresccd.org/Main_Page and create a new Parallels VM booting from the .iso that you just downloaded. When configuring the VM add the XP disk as a second disk for the VM. Boot the new VM and launch an application on the desktop called GParted. This is the equivalent to Partition Magic for linux. You can use this to extend the partition to take up the new drive space that you created in step 1.
After this you should be able to go back and start the XP VM as usual with a newly sized disk.
If you have any questions feel free to ask -- I may be flying a bit blind since I am running Parallels 3.0 and not 2.5