South Asia’s Debt Addiction
South Asia has become one of the most debt-stressed regions in the world, with the region’s total debt at close to $4 trillion. In 2022, Sri Lanka became the first Asia-Pacific nation to default in the 21st century. Pakistan and Maldives came close to default and countries like Bangladesh and Nepal have structural issues that could exacerbate their debt problem in the long term. The region has been quite dependent on the lender of last resort, the International Monetary Fund (IMF) with 84 IMF programs in total over the decades.
Sovereign debt crises nowadays are not just economical but also geopolitical, directly shaping national sovereignty. Weak fiscal accounts and current accounts lead to borrowing externally, thus reducing policy autonomy and leading to rising foreign influence. South Asia’s growing sovereign debt burden is becoming a key determinant for geopolitical alignment in the Indo-Pacific.
Why Has Debt Increased in South Asia?
Global debt surpassed $100 trillion in 2024, which is a serious problem for the global economy. Developing countries are seeing public debt grow twice as fast as developed nations, resulting in developing countries paying $921 billion in 2024 for interest payments alone. The debt composition is also shifting toward commercial borrowing from international capital markets.
South Asia, which consists of developing nations, is proof of the global pattern. Debt levels are over 100 percent of GDP in Bhutan, Maldives, and Sri Lanka though Sri Lanka and Maldives are in much greater debt stress. Debt servicing is worrisome in Pakistan and Sri Lanka as their gross financing needs are over 20 percent of their GDP. Pakistan has a much lower debt-to-GDP ratio but its debt sustainability level is still worrying. Bangladesh, though its debt-to-GDP level is low, has a government revenue-to-GDP ratio below 10 percent, making its debt sustainability shaky in the long term. Nepal has lower debt-to-GDP levels and has higher revenue to GDP compared to its South Asian peers but there is reason for concern over the long term.
The South Asian region has a diverse collection of economies with differing levels of debt sustainability. But there are some themes that reappear many countries: chronic fiscal deficits, protectionist economies, and narrow tax bases.
South Asia is notorious for populist policies resulting in a culture of subsidies to sustaining unprofitable state-owned enterprises. The deficits as a result of this fiscal indiscipline have resulted in debt being accumulated to bridge the gap. Sri Lanka is an example of a nation with chronic fiscal deficits where debt and monetary financing was used to bridge the gap. In 2023, Sri Lanka enacted the Central Bank Act to give independence to the Central Bank, which has eliminated the option of monetary financing.
Trade protectionism has dominated South Asia for decades, and this has resulted in the region not gaining the benefits of globalization. Even within the region, trade levels are dismal; South Asia has the lowest intra-regional trade in the world. This has placed South Asian nations behind China and Southeast Asian nations that took advantage of globalization by having greater trade liberalization and increased trade facilitation.
The fact that many South Asian economies depend on tourism, remittances, and commodity exports makes the nations vulnerable to external shocks. Sri Lanka and Maldives depend on tourism for foreign exchange earnings. Pakistan, Nepal, and Sri Lanka depend on remittances. Exports are largely focused on commodities – for example, Sri Lanka’s largest exports are apparels and tea, and around half of Sri Lanka’s exports are to the West. So if there is a recession in the United States or Europe, Sri Lanka’s current account is affected. These nations also depend on energy imports, which makes their economies vulnerable to global oil price fluctuations.
Graduating to middle income status also resulted in countries like Sri Lanka losing out on concessional multilateral and bilateral lending, so they had to turn to international capital markets. China also emerged as a strong creditor in the mid 2000s. Nepal is set to become a middle income nation in the coming years. This could result in Nepal too having to switch borrowing away from concessional lending. which could have a negative effect on its debt sustainability.
How Sovereign Debt Erodes Economic Sovereignty
As sovereign debt rises, the government loses fiscal autonomy. The fiscal space is increasingly taken up by interest payments. Sri Lanka is a prime example of this: around half of Sri Lanka’s government recurrent expenditure is set to be spent on interest payments alone for 2026. Sri Lanka has one of the highest interest payments to expenditure ratios in the world.
As governments lose fiscal space, they are also unable to conduct countercyclical fiscal policy. This can make recessions in countries with high debt last much longer. Governments are also unable to give concessional tax rates and subsidies for businesses, resulting in losing competitive advantage to other countries. This also results in governments increasingly depending on treasury bills and bonds, which are at the mercy of the markets, to run the government.
A large part of the debt is from domestic borrowing as well. This results in a crowding out effect, meaning higher interest rates for the private sector, taking away their global competitiveness. On the other hand, local financial institutions can also influence fiscal policy as they make the decisions to buy treasury bills and bonds.
Also, when nations are in high debt, they appeal to the IMF for assistance which also results in economic policies being set by the IMF as part of its conditions. Governments thus lose further economic independence as nations become dependent on foreign powers and institutions for survival. This can result in macroeconomic policies being designed, usually in partnership with the IMF, for the long term. This will result in governments losing control of both fiscal and monetary policy in the medium term.
Pakistan is an example. When it is in economic need, it receives loans from China and/or the IMF. Pakistan as a result cannot pursue a foreign policy independent of China or the West as it needs them both.
Sri Lanka is another example. China was the largest bilateral lender at the time of Sri Lanka’s default. In 2017, Sri Lanka’s inability to pay loans resulted in Sri Lanka’s Hambantota Port being taken over by a Chinese state-owned firm. Sri Lanka also experienced first hand the geopolitical rivalry between China and the West when China delayed giving financing assurances for Sri Lanka to start the IMF program. China argued that multilateral debt of U.S.-dominated institutions such as the World Bank and the IMF should also be restructured. As a principle, multilateral debt is not restructured. Though China gave financing assurances eventually, its reluctance delayed Sri Lanka beginning its IMF program.
The Great Power Competition
The Indian Ocean is one of the most important areas where geopolitical rivalry is set to take off. As other regions have a global West vs China competition, the Indian Ocean brings an emerging global power and a very dominant regional power, India, into the mix. As nearly 80 percent of India’s oil imports and 90 percent of its trade volumes come through the Indian Ocean, India has strong reasons to ensure stability in its backyard. This decade has also seen India positioning itself as an economic stabilizer, as it helped Sri Lanka with $4 billion in 2022, which prevented Sri Lanka from descending into further chaos. India has also helped Maldives.
The debt restructuring in Sri Lanka saw clear divisions as India took the lead in helping Sri Lanka with $4 billion in 2022. India along with Japan and France initiated the Official Creditor Committee to smoothen the restructuring of Sri Lanka’s debt. China, Sri Lanka’s largest creditor, wanted to negotiate separately with Sri Lanka.
Analysts in the West have long argued that Chinese lending creates long term leverage and a so-called “debt trap.” But it must be noted that Chinese debt in the case of Sri Lanka was less than 10 percent of Sri Lanka’s total debt, with the largest amount owed to international bondholders.
But at the same time, Chinese loans had come with little conditions and were easier to obtain, resulting in mounting debt for white elephant projects. Compared to this, Western lending came with multilateral conditionality.
What Can South Asian States Do to Regain Economic Sovereignty?
To avoid the loss of sovereignty associated with mounting debt, fiscal discipline is essential. Sri Lanka is an example of a country that has lacked fiscal discipline for decades. Improving tax revenue is also essential as some countries have very low government revenue-to-GDP ratios. In Bangladesh, the government revenue-to-GDP ratio is less than 10 percent. Sri Lanka and Pakistan have gross financing needs that are over 20 percent as of 2024, which makes them extremely dependent on borrowing to sustain their governments. Rationalizing government expenditure through digitization, elimination of corruption, and increased transparency can help bring fiscal discipline. Fiscal discipline also results in improved credit ratings, which decreases borrowing costs and helps investment inflow.
Second, South Asian states much reduce external commercial borrowing. An UNCTAD report showed that developing world debt is increasing twice as fast as the debt in the developed world – and developing nations are increasingly borrowing from international capital markets. Limited and sustainable borrowing from international bondholders is not harmful but excessive borrowing can make countries vulnerable. Bond rates are volatile, being influenced by various global factors. Borrowing from commercial markets can also be much costlier as developing nations have lower sovereign credit ratings.
But countries face a lack of clear alternatives. As countries in South Asia become middle income nations, they lose access to concessional funding from multilaterals and bilaterals. Switching to domestic borrowing can also lead to higher interest rates for the private sector and most countries have issues in balancing their current accounts, so foreign exchange borrowing is needed.
The solution is to take a long-term perspective by looking at trade and investment as the alternative to gradually move away from debt. South Asia has the lowest intra-regional trade in the world. Protectionist policies and lack of integration into global supply chains have consistently held the region back. Trade liberalization and trade facilitation can help increase exports, which can bring in foreign exchange. A liberal trade regime can also result in South Asia attracting export oriented investment. Reduction in red tape, policy consistency, and structural reforms can also drive investments, which can help make the South Asian economies stronger and more debt resilient.
