South Asia is struggling to balance sovereign debt and fiscal space. The region’s debt has risen faster than in any other emerging region due to persistent fiscal deficits. By 2023, the government debt had surged to 77 percent. In 2022, Sri Lanka entered a sovereign debt crisis and defaulted, followed by a narrowly avoided default by Pakistan in 2023. Bangladesh’s reach for IMF support further illustrates the severity of dwindling reserves. The leading economy of South Asia, India, also carries higher public debt levels at 80 percent of its GDP, whereas smaller states like Nepal, Bhutan and the Maldives rely on concessional finance to stay afloat.

This high level of debt and its vulnerability lie both in its scale and structure. On the one hand, narrow tax bases, inefficient state enterprises, heavy dependence on imported fuel and commodities have constrained fiscal space, whereas limited trade integration and cooperation deepen the region’s dependence on external partners. High debt leaves fewer financial resources allocated for development priorities and social safety nets. This reshapes the state’s priorities as public finance becomes less accessible.

External shocks

Covid-2019 pandemic and the Russia-Ukraine war have exposed the limitations of South Asia’s prosperity as conditional on global price volatility. Between 2020 and 2022, energy and food prices spiked, driving up import bills and diminishing foreign reserves. With reserves falling, governments borrowed more to keep the country functioning and to restock the basic needs, i.e., energy and commodities. Inflation soon followed across the region, which was not a by-product of supply excess but a result of higher import costs and global supply disruptions. For instance, consumer prices rose by 50 percent in Sri Lanka in 2022, and by over 30 percent in Pakistan in 2023. Even Bangladesh, known as the tiger economy, saw inflation exceeding 8 percent by 2025. India’s diversified economy, which is more resilient and supported by a discounted energy deal with Russia, is struggling to keep its rate near 3 percent, at the cost of state subsidies.

For millions across South Asia, each global crisis now arrives first at the fuel pump and the market stall. This is further compounded by the new trade reality. In 2025, the United States, South Asia’s largest textile buyer, slapped tariffs of 20 to 50 percent on apparel and labour-intensive exports that have challenged the global competitiveness of Bangladesh’s garments, Sri Lanka’s apparel and India’s clothing sector. This is a big blow to governments reliant on export earnings to service their debt, as the tariffs reduce competitiveness and compound existing structural issues.

Structural issues

Domestic structural issues, such as weak revenue systems and politically popular subsidies, have left governments unable to cushion external shocks and fragile 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, as government revenue collection remains lower and higher subsidies mean funds dedicated to other sectors need to be diverted to pay for these subsidies. Across the region, subsidies act as a tool to serve political leverage rather than economic efficiency.

In addition, 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 an effect of structural policy choices. South Asian politics often prioritise short-term populist measures over fiscal prudence, which erodes its responsive capacity during crises and hinders recovery.

Climate as a new challenge

Climate change is further complicating the countries’ already fragile fiscal space as the region remains highly vulnerable to climate shocks such as floods, heatwaves and erratic monsoons that have destroyed crops, livelihoods, human settlements and infrastructure. In 2022, floods in Pakistan alone caused more than $30 billion in damages and impacted millions of livelihoods. In Bangladesh, rising heat reduces labour productivity by an estimated 25 million workdays and $1.8 billion annually, and 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 that deepens fiscal stress, while the benefits are often limited, which barely reduces future risks. This “climate-debt trap” punishes countries twice, first through damage, then through debt. In the absence of adequate concessional finance, fiscal stability will remain hostage to the cyclical climate shocks. Debt-neutral relief instruments like debt-for-climate swaps and risk-pooling funds can provide immediate funding needs during times of crisis; however, adoption remains slow as regional cooperation remains politically constrained and measures are lacking.

Crisis management

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 also secured a $1.7 billion Extended Fund Facility in 2023 that helped to stabilise its currency, but the public debt remains unsustainable. Pakistan secured $3 billion in 2023 and $7 billion in 2024 from the IMF, that have helped contain inflation; however, debt servicing swallows 60 percent of its revenues.

Similarly, Bangladesh secured a $4.7 billion programme to contain current account deficit and inflation through exchange-rate adjustments, which is 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. Across the regions, these IMF programmes have bought time and helped countries during the most urgent crises. However, countries should take this as an opportunity to rebuild their fiscal discipline and debt.

Way forward

In the medium term, the region needs a cooperative framework that promotes economic resilience as a collective tool for mutual growth. One example is the potential of the regional power trade between Bhutan, Nepal and India that 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 that can be modelled on 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, the government should broaden its tax bases, curb politically motivated subsidies and restructure loss-making state-owned enterprises. The fiscal deficit gap can be further closed by aligning fuel and electricity prices at market levels and ensuring the protection of low-income households, which can work well, especially in the energy sector. Similarly, 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. The government should also ensure that new borrowing supports productive investment rather than political consumption.

South Asia’s future hangs in the balance of 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.