By Emma Clark BBC News Online business staff

When the US declared war on Afghanistan's Taleban last October, the president of Pakistan took a massive gamble.

By siding with the US in the conflict, President Pervez Musharraf risked considerable internal strife at home and compromising his own popularity.

Annual growth rates

2002/03: 4% (estimate) 2001/02: 3.6% 1990s average: 2.5% 1980s average: 6%+

After the Taleban came to power in the late 1990s, Pakistan was one of only two countries to recognise the legitimacy of its government.

But the 11 September attacks on New York and Afghanistan's reluctance to give up the prime suspect Osama Bin Laden were to change everything.

At that time, President Musharraf faced a critical decision - he could continue with his country's support of the Taleban or he could forge a tacit, but powerful alliance with the US.

Nuclear no-no

Since the country's nuclear tests of May 1998, Pakistan had tasted only cold disapproval from the world's superpower.

Nuclear tests provoked sanctions from the US

Its economic reforms prior to May 1998 had foundered in the face of tough sanctions imposed by the US.

The events of 11 September presented Pakistan with a one-time opportunity for international rehabilitation.

And so President Musharraf declared his hand and joined the Western coalition against Bin Laden's al-Qaeda fighters.

Economic rewards

The economic benefits of such a policy were compelling.

Once Pakistan was firmly on-side, sanctions were lifted and the International Monetary Fund (IMF) resumed lending to the country.

The US alliance bought Pakistan some debt relief

By December, the IMF had promised a $1.3bn loan (�866m) over three years to reduce the country's poverty.

Further grants and loans followed and - more importantly - the Paris Club of creditors re-scheduled some of Pakistan's crippling debt repayments.

Pakistan's total debt burden - about $60bn - was equal to 115% of its gross domestic product in 2001, according to Kristin Lindow of Moody's Investors Service.

Its foreign debt alone - about $35bn - was worth 250% of exports.

The debt re-scheduling took the pressure off and boosted investor sentiment, says economist Aqib Elahi Mehboob at the Karachi brokerage Khadim Ali Shah Bukhari & Co.

Banking boost

Pakistan's foreign reserves were also boosted to $7.2bn this year from $700m in 1999, after a clampdown on terrorist financing reduced use of the informal hawala banking system.

Vital statistics

Income per capita of $420 a year 31% of population lives on less than $1 a day, while 85% lives on less than $2 Adult illiteracy of 57% One in 10 children die before five years old Source: World Bank

The mass of Pakistani workers sending money home from abroad switched to using Pakistan's state and commercial banks.

This increased the country's reserves and eased pressure on the rupee.

The greater stability of the currency has since helped to bolster the confidence of importers buying the country's goods.

Conflict costs

But for all these benefits, Pakistan has paid a high price for its proximity to Afghanistan.

Tensions with India have hurt confidence

The campaign in Afghanistan immediately disrupted Pakistan's exports, while shipping and insurance costs shot up.

The Pakistani government has estimated that the war cost the economy up to $2.5bn, although Mr Elahi Mehboob says the figure is closer to $2bn.

The crackdown on religious extremism in Pakistan has also sparked a backlash, making foreign nationals in the country a target for further terrorist attacks.

"This has repercussions for investment into Pakistan," says Mr Elahi Mehboob.

In addition, ongoing tensions with India over the Kashmir question have contributed to the plunge in investor confidence.

Cause for hope?

Both Mr Elahi Mehboob and Gareth Price, a Pakistan expert at the Economist Intelligence Unit, believe the costs of 11 September to the economy actually outweigh any benefits.

Recent terrorist attacks have scared investors

Mr Price is also pessimistic about President Musharraf's stab at economic reform, including a welcomed float of the rupee.

"There are so many things to resolve at once," he says.

He adds that the economy is over-reliant on the cotton and textiles industry, which makes up 65% of its exports.

Finally, economic growth, which is at about 4% this year, needs to climb to at least 5% to make any impact on easing the country's extreme poverty.

Indeed, painful reforms such as liberalising fuel prices and increasing the tax base have conspired to make the country's people even poorer.

Mr Price's main hope is that the IMF money will eventually help in the long-term to develop the economy.

The government is also pinning its hopes on enhanced trade access to the US textile market.

The European Union has already granted this concession to Pakistan, but it has not happened yet in the US because of political sensitivities.

But for the time being, Pakistan's economy will limp on, in spite of its president's tactical manoeuvring and its new role in the world order.