I am writing about what I observed during my recent, two weeks visit to Pakistan. I arrived in the country on September 4 to the news that the Americans had escalated their attacks on the suspected hide-outs of terrorists in the FATA.

On September 3, they sent in their troops into the Pakistani territory in hot pursuit of suspected terrorists. This was a clear violation of the basic principles of international law – one that is the cornerstone of the United Nations system. According to this, no state will go into the territory of another sovereign state.

I left Pakistan a few hours after a suicide bomber set fire to his explosive-leaden truck outside the Marriott hotel at Islamabad, killing at least 53 people and injuring more than 200. Among the dead were a number of foreigners, including the Czech ambassador. These were confidence shattering events for the economy. They have reinforced the view that Pakistan is a dangerous place to do business with. It will have a enormously negative impact on the economy.

I took the British Air flight out of Islamabad to London. It was full of foreigners that suggested to me that there was some traffic between Pakistan and the world outside. The passenger sitting next to me had gone to Islamabad to hold discussions with a software company with which he had been doing business for a couple of years. He was impressed with the talent the Pakistani company had employed. The work he had farmed out was sophisticated and the local company had handled it very well.

He was of the view that having missed the opportunities India had used so productively for obtaining outsourced work, Pakistan seemed to be catching up. What was even more important was the fact that while the Indian software companies had plucked the low-hanging fruits such as data feeding, medical and legal transcriptions, architectural drawings and call centres, Pakistanis were going for the more value added work related to product development and servicing the products that were sold.

He saw Islamabad and Lahore emerging as important centres for software development and export. This was in keeping with the trend in other centres of software development that were also located near educational and research institutions. Both the two cities had developed institutions that focused on science and technology.

My fellow passenger said that his local partner had its offices right next to the Marriott where he stayed when he was in Islamabad and walked to the software centre a couple of blocks away. It was a very convenient arrangement and Islamabad was a very attractive city to spend a few days in. I doubt he would be returning to Islamabad any time soon. A couple of days after the Marriott was destroyed by the truck bomb, the British Air suspended its Islamabad-London flight and Pakistan lost another link with the outside world.

The Marriott bombing was aimed to inflict economic damage on Pakistan. Although the loss of life was less than that in Karachi last October when the terrorists struck Benazir Bhutto’s motorcade, its economic consequences will be much more severe. The service sector is likely to be hurt a great deal as people avoid public places such as large shopping centres and hotel lobbies. Since the attack occurred a day after the announcement by the government that it was undertaking a massive restructuring of its finances, the positive impact of that development was lost on the markets.

The terrorist attack has done incalculable damage to the economy that was struggling to recover from a deep crisis. I found the country in great deal of economic stress and the government almost paralysed into inaction. There was anecdotal evidence of capital flight which always results when there is loss of confidence in the future. I heard that people were buying properties not only in the Middle East – in particular in such booming cities as Dubai, Abu Dhabi, Bahrain and Doha – bit also in Malaysia.

The Islamabad bombing probably exacerbated and, most probably, caused additional capital to flee the country. The flight of capital put simultaneous pressure on the value of the rupee which continued to slide. It also put additional burden on the stock market which also continued its downward spiral.

How would the increase in terrorism and continued conflict in the tribal areas affect the economy? For this question to be answered, the policy makers must have access to better information about the state of the economy. However, that is not the case. Most developing countries update their national income accounts every quarter; in the case of Pakistan this is done on an yearly basis which means that if the policymakers wish to take remedial action to correct some aspect of the economy they have to operate blindfolded.

In the table accompanying this article, I have attempted to forecast how the economy may perform this year given all the uncertainties that surround it. This should help focus the attention of the policy makers on the areas that are being hurt as a result of the uncertainty caused by the activities of the terrorists.

I expect the rate of growth of GDP to decline to 4.2 per cent, more than one and half percentage points lower that of last year’s increase of 5.8 per cent and much lower than the average for the last six years of about seven per cent. I expect manufacturing and construction to suffer the most, in part because of the persistent shortages in electricity and likely increase in the demand-supply gap for natural gas.

The rate of growth of manufacturing is likely to be the lowest in many years. It will be about the same as the increase in the gross domestic product. According to my estimates agriculture will do relatively well. Its growth rate should be four per cent, more than two and a half times that of last year. The increase in commodity prices will help the farmers produce greater quantities of output.

The worrying part of this anticipated loss in growth momentum is a significant increase in unemployment. The economy will create far fewer jobs than the growth in the workforce. The sectors that provide jobs to the poorer and less educated and trained workforce are expected to do less well. Their poor performance will not be because of the terrorist attacks. It will be because of the havoc caused by interruptions in the supply of electric power during the summer months.

The government’s decision to twist the arms of the commercial banks to lend working capital to Wapda so that it could clear its bills that were pending from the independent power producers reduced the duration of load-shedding. The IPPs went back to producing electricity in keeping with their installed capacity. However, the damage to the economy had been done.

The most important impact of terrorist activity will be to reduce the flow of private finance into the country. This will happen at the time when Pakistan is running very high trade and balance of payments deficits. These have to be financed. Even after taking into account a significant increase in workers’ remittances to about $ 7 billion in 2008-09, there will still be a financing gap of some $5 billion.

At this point there is no indication by the government as to how it proposes to finance this deficit. Whether the terrorists intended it that way or not, their activities have seriously imperilled the economy.