South Asia’s Debt Dilemma: A Region in Crisis
South Asia is facing a growing challenge in managing its sovereign debt and fiscal space. The region’s debt has increased at a faster rate than any other emerging market, driven by persistent fiscal deficits. By 2023, government debt had reached an alarming 77 percent of GDP. This trend was highlighted by Sri Lanka’s sovereign debt crisis in 2022, which resulted in a default, followed by a near-default in Pakistan in 2023. Bangladesh’s request for IMF support further underscores the severity of the situation. Even India, the region’s largest economy, carries public debt at 80 percent of its GDP, while smaller states like Nepal, Bhutan, and the Maldives depend on concessional finance to maintain economic stability.
The high level of debt and vulnerability are not just about the scale but also the structure of the region’s economies. Narrow tax bases, inefficient state enterprises, heavy reliance on imported fuel and commodities have constrained fiscal space. Limited trade integration and cooperation have deepened dependence on external partners. As a result, high debt levels leave fewer financial resources available for development priorities and social safety nets, reshaping the state’s priorities as public finance becomes less accessible.
External Shocks: Pandemic and War
The global shocks of the COVID-19 pandemic and the Russia-Ukraine war have exposed the fragility of South Asia’s prosperity, which is heavily dependent on global price volatility. Between 2020 and 2022, energy and food prices surged, increasing import bills and reducing foreign reserves. With reserves falling, governments borrowed more to keep their countries functioning and to restock essential needs such as energy and commodities. Inflation soon followed, not due to supply excess but because of higher import costs and global supply disruptions.
For example, consumer prices rose by 50 percent in Sri Lanka in 2022, and by over 30 percent in Pakistan in 2023. Even Bangladesh, often referred to as the tiger economy, saw inflation exceed 8 percent by 2025. India, with its diversified economy and discounted energy deals with Russia, is struggling to keep its inflation rate near 3 percent, albeit at the cost of state subsidies.
New Trade Realities
The new trade reality has further complicated matters. In 2025, the United States, South Asia’s largest textile buyer, imposed tariffs of 20 to 50 percent on apparel and labor-intensive exports. This has challenged the global competitiveness of Bangladesh’s garments, Sri Lanka’s apparel, and India’s clothing sector. For governments reliant on export earnings to service their debt, these tariffs reduce competitiveness and compound existing structural issues.
Structural Issues: Weak Revenue Systems and Subsidies
Domestic structural issues, such as weak revenue systems and politically popular subsidies, have left governments unable to cushion external shocks and maintain fiscal space. In Pakistan, for instance, artificially low electricity tariffs created a “circular debt” in the power sector that keeps returning to the state’s books. Government revenue collection remains low, and higher subsidies mean funds dedicated to other sectors must be diverted to pay for these subsidies. Across the region, subsidies act as a tool for political leverage rather than economic efficiency.
Weak tax bases further reduce the fiscal base. Available data shows that in 2024, only 3 percent of citizens filed income taxes in Pakistan, compared with 1.4 percent in Bangladesh in 2022, and around 7 percent in India. State-owned energy enterprises in Sri Lanka and Bangladesh continue to drain public finances. These are not just economic inefficiencies but the result of structural policy choices. South Asian politics often prioritize short-term populist measures over fiscal prudence, eroding responsive capacity during crises and hindering recovery.
Climate Change: A New Challenge
Climate change is further complicating the already fragile fiscal space in South Asia. The region remains highly vulnerable to climate shocks such as floods, heatwaves, and erratic monsoons, which have destroyed crops, livelihoods, human settlements, and infrastructure. In 2022, floods in Pakistan alone caused over $30 billion in damages and impacted millions of livelihoods. In Bangladesh, rising heat reduces labor productivity by an estimated 25 million workdays and $1.8 billion annually. Across India, Nepal, and Bhutan, disrupted hydropower and rising cooling demand are driving up fuel imports and public spending.
These climate shocks trigger new borrowing as adaptation finance is often loan-based. Governments accumulate debt for resilience, deepening fiscal stress, while the benefits are often limited, barely reducing future risks. This “climate-debt trap” punishes countries twice, first through damage and then through debt. In the absence of adequate concessional finance, fiscal stability will remain hostage to cyclical climate shocks.
Crisis Management: IMF Assistance
In recent years, South Asian governments have repeatedly turned to the IMF to avert default. India supported Sri Lanka with $4 billion in financial assistance and secured a $1.7 billion Extended Fund Facility in 2023 that helped stabilize its currency, though public debt remains unsustainable. Pakistan secured $3 billion in 2023 and $7 billion in 2024 from the IMF, helping contain inflation, but debt servicing now consumes 60 percent of its revenues.
Similarly, Bangladesh secured a $4.7 billion program to contain current account deficit and inflation through exchange-rate adjustments, still dealing with a slow economic recovery. Smaller nations like Nepal and Bhutan, with narrow fiscal space, continue to rely on aid, remittances, and concessional loans to keep their economies afloat. While IMF programs have bought time and helped during urgent crises, countries should use this as an opportunity to rebuild fiscal discipline and debt management.
Way Forward: Cooperation and Reform
In the medium term, the region needs a cooperative framework that promotes economic resilience as a collective tool for mutual growth. Potential regional power trade between Bhutan, Nepal, and India could cut energy imports and save about $9 billion annually by 2040. Expanding intra-regional trade, which stands at around $23 billion in 2022 compared with a potential $67 billion, can further reduce exposure to global supply shocks.
Equally important is establishing a risk insurance facility modeled after the Caribbean’s Climate Risk Insurance Facility to provide rapid liquidity after disasters without adding new debt. These shared risk-pooling mechanisms can turn fragmented vulnerabilities into financial resilience, offering a useful incentive for cooperation.
In the short run, through domestic reforms, governments should broaden tax bases, curb politically motivated subsidies, and restructure loss-making state-owned enterprises. The fiscal deficit gap can be closed by aligning fuel and electricity prices at market levels and ensuring protection for low-income households, especially in the energy sector. Fiscal institutions’ capacities must be strengthened in ensuring transparent debt reporting, adopting a medium-term expenditure framework, and integrating climate risk consideration into fiscal budgets. New borrowing should support productive investment rather than political consumption.
South Asia’s future hinges on whether countries want to fight the crisis alone or commit to rebuilding their fiscal space together. The region’s next chapter need not be defined by recurring bailouts and shrinking economic growth. South Asia must turn shared vulnerabilities into mutually inclusive resilience and growth by ensuring fiscal reforms at home and regional integration abroad.
