South Asia Development Update October 2023

At just under 6 percent, output growth in South Asia is expected to remain stronger than in other regions in 2023–25, even with weak growth in the countries recovering from recent balance-of-payments crises. Foreign exchange and financial markets in these countries have stabilized, in part owing to the introduction of IMF-supported policy programs. But the financial systems of many countries in the region remain vulnerable and fiscal positions remain fragile. In some cases, restrictions on imports and foreign exchange transactions have yet to be fully unwound. The outlook is subject to downside risks from weak financial systems and fiscal positions. Growth prospects would also worsen in the event of a further economic slowdown in China or climate change-related natural disasters. In the short term, policy priorities include preserving financial stability and improving fiscal sustainability. In the longer term, it is important to boost private investment growth, make economies more open to trade, and seize the opportunities offered by the global energy transition.

Among EMDEs, primary fiscal deficits, primary government expenditures, and government wage bills have tended to rise significantly around election years. While primary spending increases have tended to be partially reversed in the following year, post-election reversals of primary deficit and government wage bill increases have been more variable and at best partial. The consequent ratcheting up of primary deficits around elections in EMDEs can erode fiscal sustainability over the longer term, while the expansion of government wage bills can result in spending rigidities. In South Asia, in particular, fiscal positions have tended to deteriorate around national elections, and, in some cases, there is also evidence of targeted fiscal actions around subnational elections. While this result is true on average for the region, some countries—notably India in its 2023 budget—have avoided the risk of election-induced current spending increases. This points to a way forward for fiscally constrained governments in South Asia.

South Asia has the highest average government debt-to-GDP ratio among emerging market and developing economy (EMDE) regions, at 86 percent in 2022, and four of the region’s countries are rated in or near sovereign debt distress. The risk of sovereign defaults in the region is heightened not only by high levels of government debt but also by the increases in global interest rates over the past two years: the vast majority of past defaults occurred around the end of U.S. monetary policy tightening cycles and in countries with above-median government debt-to-GDP ratios. Past experience also shows that more than one-third of defaults failed to lower government debt or borrowing costs in a lasting manner. Defaults that succeeded in lowering debt or borrowing cost were accompanied more frequently than others by above-median debt restructurings, growth accelerations, and fiscal consolidations. South Asia’s above-average economic growth mitigates some of the default risks. Some South Asian countries have reduced their default risk by predominantly borrowing from domestic creditors. However, this strategy comes at a price: high domestic shares of government debt have been associated with higher borrowing costs and lower bank credit to the private sector. With the external environment likely to remain challenging over the next several years, it is all the more important to adopt policies to accelerate sustainable growth and shore up fiscal positions.

As the world presses ahead with the energy transition, new energy-saving technologies offer South Asian countries an opportunity to modernize their economies. Currently, the energy intensity of output of South Asian economies is almost twice the global average—despite a decline over the past two decades that was almost entirely driven by firm-level, within-sector cuts in energy intensity. While the region’s firms have been early adopters of basic energy-saving technologies, they have lagged in the adoption of more advanced technologies, with smaller firms lagging particularly far behind. Policies that have been effective at encouraging technology adoption among firms include market-based regulation, dissemination of accurate information on energy savings, and financial support.

The transition away from fossil fuels in South Asia will have significant labor market impacts, which could leave many workers stranded in lower-wage jobs in declining industries. In all South Asian countries except India, pollution-intensive jobs outnumber green jobs and account for 6–11 percent of all jobs; only in India do green jobs outnumber—and then only slightly—pollution-intensive jobs, which account for 9 percent of all jobs. Pollution-intensive jobs are concentrated among lower-skilled and informal workers, whereas green jobs tend to be held by higher-skilled, better-paid, and formal-sector workers. Experience from past major economic transformations, especially in resource sectors, suggests that the transition from fossil fuels will have large effects on the structure of employment and earnings, with lasting losses for some workers, and can cause significant internal worker migration. A wide range of policies will be needed to facilitate the necessary adjustment in labor markets while protecting vulnerable workers. These include: the provision of better access to high-quality education and training, finance, and markets; measures to facilitate labor mobility; and strengthening social safety nets.

The number of emerging markets and developing economies in debt distress is currently the largest since 2000. With global growth slowing and interest rates remaining high, the next few months may bring more countries to the brink of sovereign debt distress.

South Asia’s transition away from fossil fuels will have significant labor market impacts, which could leave many workers stranded in lower-wage jobs in declining industries. In most South Asian countries, pollution-intensive jobs outnumber green jobs.

New energy-saving technologies offer South Asian countries an opportunity to modernize their economies, and will be an integral part of their energy transition. The energy intensity of output of South Asian economies is almost twice the global average—despite a decline over the past decade that is largely attributable to firm-level, within-sector cuts in energy intensity.

Output growth in South Asia is projected to remain stronger than in other regions, but is nonetheless not strong enough for most countries to reach high-income thresholds within a generation. A sustained acceleration would require stronger private investment growth, which has been weak in most countries.

At first glance, South Asia is a bright spot in the global economy. The World Bank is forecasting that the region will grow more quickly than any other developing country region over the next few years. Some countries in the region are continuing a trend of strong growth, while others are recovering from a period of turmoil.

High levels of government debt in the Emerging Market and Developing Economies (EMDEs), as well as the increases in global interest rates over the past two years, currently heighten risks of debt default in EMDEs.