Pakistan appeared to be well on the road to full diplomatic rehabilitation on Sunday following Washington's announcement that it was lifting all sanctions imposed on both Pakistan and India after the two countries carried out nuclear weapons tests in 1998.

The move, which follows Pakistan's decision to provide its "full support" to the US-led war on terrorism, puts Pakistan back on broadly the same diplomatic track as India. Prior to the September 11 terrorist attacks in the US, American officials had indicated that they would remove sanctions on India well in advance of those on Pakistan.

The sanctions included a ban on military sales to both countries and a block on certain types of development aid. Separate sanctions imposed on Pakistan in 1999, following General Pervez Musharraf's military coup, will probably remain in place until democracy is restored.

"We are very pleased by the lifting of sanctions and we hope to discuss further ways in which the US can assist our economy in the weeks ahead," said an official at the Pakistan finance ministry on Sunday.

The presidential waiver, signed by Mr Bush at Camp David on Saturday night, also coincides with Pakistan's first ever graduation from an International Monetary Fund stand-by loan this week. The $560m one-year loan, which has restored something close to economic stability in Pakistan, is expected to be followed by agreement on a $2.5bn to $3bn three-year IMF programme in the near future.

In addition, Pakistan and US officials will today sign an agreement in Islamabad that reschedules $379m worth of Pakistan arrears to the US, the default on which had previously triggered an additional layer of US sanctions. These will be lifted in 30 days.

Western diplomats say that there is also growing consensus on the need to provide broader assistance to help cushion Pakistan from the recent global economic shock, as well as reward the Islamabad government for its support to the US-led war on terrorism.

"Pakistan has done all the right things to graduate from the IMF stand-by loan and we want to make sure that the current shock to the global economy doesn't tip Pakistan back into a crisis," said a western diplomat in Islamabad.

Pakistan officials say they are optimistic that the country will get relief on the country's $36bn worth of sovereign external debt. Last week Japan, the country's largest creditor, by-passed its own nuclear sanctions on Pakistan to provide $40m in emergency assistance to Islamabad. Others, including Britain and France, are thought to be looking at ways of assisting Pakistan.

The country, which has just $1.7bn in foreign exchange reserves, covering barely eight weeks worth of imports, is expected to see a rapid fall in its export earnings owing to what is expected to be a sharp increase in the cost of insurance for shipping and air freight services from the country.

The rising price of oil, which accounts for about a third of the country's import bill, could also hit economic performance. Furthermore, Pakistan consumers are already suffering from a confidence crisis. In the aftermath of the terrorist attacks, sales have plummeted by as much as 25 per cent, according to retail traders in Islamabad.

Although largely symbolic, the waiver on nuclear-related sanctions could also go some way towards restoring confidence, say officials. Among other things, the move will permit the US to vote in favour of loans to Pakistan at the IMF and World Bank. It also lifts restrictions on credit financing to Pakistan by the US Export Import Bank in Washington.

A ban on assistance by the US Overseas Private Investment Corporation will remain in place under the democracy sanctions.