The rich world’s financial system is in a major and persistent turmoil. On the real economic side, all the advanced economies — representing over 60 per cent of global GDP — entered a recession even before the massive financial shocks that started in late summer.

Contrary to earlier assumption that the phenomenon was to be a US-limited sub-prime mortgage crisis, what is now confirmed is that this is a triple whammy of a recession, a severe financial crisis and a severe banking crisis.

What is scary is that there is a growing disconnect between increasingly aggressive policy actions and strains in the global financial market. When AIG was bailed out to the tune of $85 billion, the market fell five per cent. When the $700 billion US rescue package was approved, markets fell another seven per cent in two days.

As authorities in the US and abroad took ever more radical policy steps in the last few weeks, stock, credit and money markets fell further, day after day for most days.

Even the rally following the G7 statement and radical policy actions taken to back-stop the financial system lasted only one day and was followed by two weeks of sharply falling equity prices and rising credit default swap (CDS) and credit spreads.

Policy authorities seem to have lost their credibility in financial markets as — until recently — their actions were step by step, ad hoc and without a comprehensive crisis resolution plan.

When policy actions don’t provide real relief to market participants, it is clear that you are one step away from plunging into an economic abyss. It is not surprising then that a vicious circle of de-leveraging, plummeting asset prices and margin calls is underway.

The hope that economic contraction in the US and other advanced economies would be short and shallow — a V-shaped six-month recession — has been replaced by certainty that this will be a long and protracted U-shaped recession, possibly lasting at least two years in the US and close to two years in most of the rest of the world.

And, given the rising risk of a global systemic financial meltdown, the prospect of a decade-long L-shaped recession — like the one experienced by Japan in the 1990’s after the collapse of its real estate and equity bubble — cannot be ruled out.

Impact on emerging markets: As in the case of other emerging market economies, Pakistan’s market was initially tied to the global distress only when foreign investors began pulling out their money, although the stresses in the case of Pakistan were sharper due to domestic political, economic and security situation.

As probably the worst-prepared emerging market to take on the brunt of the global shocks which began with sudden inflationary pressures and the commodity markets bubble worldwide due to drastic (and short-sighted!) cuts in Fed rates at the end of 2007 combined with the appreciation of the euro, the Pakistani rupee plunged to an all-time low, its balance of payments deficit widened to a record, and inflation jumped to a 30-year high.

It has become clear that Pakistan, and indeed even the better-performing emerging economies — like Brazil, Russia, India and China — all are now at risk of a hard landing and cannot whether the storm in isolation.

Pakistan is now one out of about a dozen emerging market economies that are in serious financial trouble: the others are Estonia, Latvia, Hungary, Bulgaria, Turkey, Korea, Indonesia, a few other ones in Central-South Europe and several Central American ones.

Whereas the Pakistani government is set on its course to settle its immediate need for liquidity somewhere between what the Finance Adviser has dubbed ‘Plan B’ and ‘Plan C’ (though it looks increasingly likely to be weighted in favour of ‘Plan C’), it is nonetheless crucial that reliance on the IMF be kept to an absolute minimum and as short-term as possible.

Unless a very large fiscal stimulus is provided to the developed world by China and the oil-rich Arab Gulf states, the global economy, in six months from now, may enter into a phase of prolonged “stag-deflation” (which implies low growth or recession with falling inflation rates and possible deflationary pressures). Thus it is likely that the coming six months will see headline inflation dip below zero. While this swing will be a plus for consumers across the globe as well as for the Pakistani man and woman in the street, that it is also a development that will promote a significant growth rotation towards the emerging Asian economies (mainly China and India).

To take advantage of these tectonic shifts in the making, what Pakistan needs to do is that it must aggressively re-orient its export/trade volume in the direction of these economies as well as broader regional trade within East Asia, on a war footing.

A rare opportunity has been thrown up for Pakistan by a crisis that began thousands of miles away on Wall Street. That opportunity is the opening up of large-scale trade with India, since India (along with China) will be one of the handful of economies that will continue to grow over the next few years (though not at the same pace as in earlier years). Of course, calculated safeguards may be placed to avoid the risk of “dumping” from other countries into Pakistan.

Even if global stag-deflation is avoided, the sharp slack in goods, labour and commodity markets will almost certainly lead to global deflationary trends over the next year. This is almost certain to happen because all the fiscal costs of bailing out borrowers and/or lenders/investors will not be inflationary. Hence Pakistanis should take some comfort and lift their morale; there is comfort to be taken in the fact that — as long as these fiscal costs are financed with public debt rather than with a monetisation of these deficits - inflation will not be a problem either in the short run or over the medium-term.

Other measures, (some of which are underway) that Pakistan should act on urgently: belt tightening in government’s current and development expenditure; raising additional resources through appropriate taxation measures (such as on agriculture, “flip” stock trades, excessive consumption, luxury items and speculative activity); removing the anti-export bias in the current trade regime; increasing microfinance outreach; and increasing productivity in agriculture and the SME sector.