For Wall Street, the week ending Friday, October 10 was the week that will enter its crowded history and would be remembered for a long time.

The week saw a number of records broken. It saw the largest weekly decline in the Dow Jones index of 30 industrial stocks which fell by 18 per cent, draining $8.4 trillion from investment and retirement accounts. This is more than one half of America’s current gross domestic product.

It saw the index move up and down by 1000 points in one day, looking for some direction before settling down for another loss of 128 points on the last trading day of the week.

This was the tenth consecutive decline in the index. Briefly the index breached the 8000 level last seen in 2003. The week had President Bush addressing the country five times, once every day, appealing for calm. He has appeared 22 times before the public in 27 days. His appeals were largely ignored.

The week saw the finance ministers of the world’s seven rich economies – the G7 – meeting the American president to indicate that the industrial countries were working together to come up with a programme all of them could support. Finally, over the weekend it had President Bush go down Pennsylvania Avenue to the headquarters of the International Monetary Fund, (IMF), to meet the finance ministers of the group known as G20.

The group includes not only the G7 but also a number of large developing countries such as Brazil, China, India, Indonesia, South Africa as well as some of the large oil-producing countries such as Saudi Arabia and Nigeria. Pakistan is conspicuously absent from the group reflecting the low position it now occupies on the international totem pole.

It was clear that the panic in the financial markets had disturbed the political world as well.

Initially the view was – a view that I shared – that the financial crisis that began in the United States and then spread to Europe would not seriously affect the economies of the developing world. Most developing countries were not closely linked with the global financial system anchored in the United States. However, on October 6, many large developing countries saw record declines in their stock markets. The declines were registered in the sectors in which there were close connections with the developed world.

India: For instance, the Indian IT companies saw sharp fall in their share prices. There was a fear that outsourcing from the stressed financial companies in the United States on which these companies depended for a significant amount of their revenues would decline. Tata Motors that had recently acquired Britain’s Jaguar saw a major fall in its share prices. Other Indian businesses with foreign assets also saw fall in their market values.

Pakistan: The price of oil fell to $77 a barrel, almost one-half of the level it had reached a couple of months ago. This put a strain on the spending plans of a number of countries in the Middle East. Some of these countries had large investments planned in Pakistan. In the light of these developments the question arises as to what is the likely impact on Pakistan of this crisis? How should Pakistan’s policy makers respond to the developments in America, Europe and the Middle East as they begin to address the problems the country is already confronted with? I will attempt to answer these questions..

Pakistan has severe economic problems of its own not connected with the financial turmoil in the United States and Western Europe. With fast depleting international reserves there is a growing fear that the country may be forced into defaulting on its foreign obligations. It was because of this fear that on October 6, both Standard $ Poor and Moody’s, two of the world’s largest rating agencies, downgraded Pakistani bonds. One such bond will run out of its term early next year and the investors have begun to fear whether Pakistan will be able to pay them back.

Pakistan now has the lowest credit rating in the developing world. According to John Chambers, managing director with Standard & Poor, “only Seychelles has a lower rating and it has already defaulted on its debt”. None of these developments are related to the financial problems faced by the industrial countries. In fact, I believe that there will be positive short-term impact on Pakistan of the current economic turmoil in the developed world. Let me explain. Pakistan’s external account situation is the result in part of the large increase in the import bill.. This happened because of the unrelenting increase in the prices of oil and several agricultural commodities imported by the country. Both food and energy price indices continued to increase through 2007-08, with the oil price increase outpacing the increase in the price rises of internationally traded agricultural products. The financial crisis has suddenly reversed these trends. The price of oil has declined by 50 per cent in a couple of months while the prices of traded food crops have registered significant drops. This should provide Pakistan with some relief and stop the rapid haemorrhaging in its foreign exchange reserves.

The structure of the Pakistani economy and the structure of its financial system will protect the country from feeling the full impact of the financial crisis in America and Europe. Pakistan is poorly integrated with the global economy. This means that the shocks being felt in developed countries will not be felt to any great extent in Pakistan. It will be spared the consequences of the unravelling in many parts of the western financial structure.

It now appears that the financial crises that have gripped America and Europe will also affect the real economies of these countries. Most experts now believe that America and Europe at this time stand at the threshold of deep recessions. The first signs of these have already begun to appear. In September, America lost 160,000 jobs; it is expected that by the end of the year there will be a reduction of one million jobs in the United States. Job losses result in declines in spending. Consumer spending is the main engine of growth in the United States. If it declines significantly, the economy will go into recession. That is likely to happen. Once an economy is in recession, there is a negative impact on imports. We will see a fairly large reduction in the American imports. Of the developing world, the country that will be affected most severely will be China which depends on exports to the United States to drive its trade oriented economy. The affect on China will be felt by a number of countries in its neighbourhood who have become important suppliers of parts and components to the rapidly transforming Chinese production system.

While China has a large trade surplus with the United States, it has begun to run trade deficits with many East Asian countries. Trade, in other words, will transmit to many developing countries the shocks of the current financial crisis in the western world.

Here again, Pakistan is likely to be protected by the underdeveloped status of its trading sector. While the United States is Pakistan’s single largest trading partner, a recession in America will not have a significant impact on either the quantum or value of exports. Most of these are in textiles which, as the economists suggest, are not highly dependent on incomes.

Even though Pakistan may escape the immediate negative consequence of the turmoil in the West, there will be long-term consequences. One of them is the possible impact on remittances from the United States. Over the years the US has become the single most important source of remittances for Pakistan, a good part of which originates not with the Pakistani workers of which there are not too many in America but from the professionals whose incomes will suffer if the US goes into a long and deep recession. What has become the single largest source of external finance for Pakistan may come under pressure.

The main conclusion that I would draw from this analysis is that the policy makers in Pakistan must make an effort to understand the nature of the economic and financial crisis in the West and adopt the policies that will prepare it for both, the short- and the long- term.