The international development-finance landscape is changing. Foreign aid is under pressure, borrowing has become more expensive, foreign direct investment (FDI) is increasingly concentrated, and developing countries face growing requirements for infrastructure, energy, climate adaptation, health, education and employment. The central issue is no longer simply how much external finance developing countries receive, but whether the composition of that finance strengthens their capacity to grow and generate the resources needed to service it.

South Asia’s Diverse Economic and Debt Profiles

South Asia illustrates this transition particularly well. It would be misleading to describe the region as uniformly over-indebted or suffering from declining foreign direct investment. The countries of South Asia have very different economic structures, export capabilities, fiscal systems, political conditions and degrees of integration with global markets. These differences explain why their debt and FDI positions vary so substantially.

The World Bank's International Debt Report 2025, based on end-2024 data, puts South Asia's external debt-to-GNI ratio at about 20 per cent and external debt at 92.9 per cent of exports. These regional indicators are relatively moderate, but they conceal considerable variation. Bhutan's external debt was equivalent to 110.1 per cent of GNI, compared with 75.6 per cent in the Maldives and 58.9 per cent in Sri Lanka. Sri Lanka's external debt-service payments were equivalent to 23.7 per cent of exports.

The differences are rooted in economic structure. India has a large and diversified domestic economy, substantial domestic savings and well-developed capital markets. Bangladesh has a large manufacturing base centred on garments but weak fiscal capacity and a stressed banking system. Pakistan has a narrow export base and persistent external financing pressures. Sri Lanka's crisis was aggravated by a collapse in tourism and foreign-exchange earnings, combined with heavy external obligations. Nepal relies heavily on remittances, while Bhutan and the Maldives are small economies whose debt burdens are large relative to their narrow productive bases. Afghanistan faces almost the opposite problem: limited access to international capital and investment rather than excessive access to commercial borrowing.

The South Asian story is therefore not one of a single regional debt crisis. It is a story of different forms of external-financing vulnerability.

India's position is fundamentally different from that of the smaller and more externally dependent economies. In 2024, its external debt was equivalent to 18.6 per cent of GNI and 82.1 per cent of exports. The country's large domestic economy, substantial foreign-exchange reserves, diversified export base and deep domestic financial markets provide significant buffers. External borrowing therefore represents only one part of India's financing structure.

India's challenge is less about external solvency than about mobilising enough productive capital to sustain investment and employment. Its rapid growth has been driven substantially by domestic demand, while services have become a major source of exports. The country's large market also makes it attractive to multinational companies seeking both production opportunities and access to consumers. These structural advantages help explain why India attracts much more FDI than other South Asian economies.

Pakistan's position is considerably more fragile. Its economy has historically depended on a relatively narrow export base, particularly textiles and other low- to medium-value products, while imports of energy and capital goods create substantial foreign-exchange requirements. Periodic balance-of-payments pressures have consequently led to repeated dependence on external financing and IMF programmes. The result is a high debt-service burden relative to export earnings. The underlying problem is therefore not simply the absolute level of debt, but the limited capacity of exports and fiscal revenues to generate the foreign exchange and domestic resources required to service it.

Sri Lanka's crisis illustrates the same relationship even more dramatically. Tourism had become an important source of foreign exchange, while the economy also depended heavily on imports. The collapse of tourism and foreign-exchange earnings during the pandemic, followed by severe macroeconomic imbalances, exposed the vulnerability created by a high external debt burden. By 2024, Sri Lanka's external debt was equivalent to 58.9 per cent of GNI and 280.1 per cent of exports, while external debt service reached 23.7 per cent of exports.

Bangladesh occupies an intermediate position. Its export-oriented garment industry has given it a significant manufacturing and foreign-exchange base, but FDI remains low relative to the size of the economy. The World Bank identifies weak revenue mobilisation, a stressed banking sector and subdued private investment as major constraints. The country's tax-to-GDP ratio has been exceptionally low, limiting the government's ability to create fiscal space for infrastructure and social investment.

Nepal's vulnerability arises from a different structural feature. Its economy is heavily dependent on migration and remittances. Remittances provide foreign exchange and support consumption, but they do not automatically generate domestic productive capacity. Nepal therefore has greater external stability than its relatively small industrial base might suggest, but the challenge is to convert remittance-supported demand into investment, manufacturing, tourism, hydropower and other productive activities.

Bhutan's exceptionally high external-debt ratio needs to be interpreted in the context of its hydropower economy and close economic relationship with India. Much of its external borrowing is associated with large hydropower projects. Its external debt was equivalent to 110.1 per cent of GNI and 349.3 per cent of exports in 2024. These figures are high, but the nature of the debt differs from that of a country borrowing heavily to finance recurrent consumption. The issue for Bhutan is whether hydropower revenues and diversification can generate sufficient returns to support the debt accumulated for infrastructure.

The Maldives represents another small-state model. Its economic base is dominated by tourism, while infrastructure requirements are large relative to the size of the economy. This creates a structural mismatch between the scale of investment required and the country's narrow domestic revenue and export base. External shocks affecting tourism can consequently have disproportionately large effects on debt sustainability.

Afghanistan represents the most distinct case. Its problem is not excessive commercial borrowing but inadequate access to productive international capital. The World Bank estimates that Afghanistan's economy grew by 4.8 per cent in 2025, but rapid population growth meant that GDP per capita fell by 5.6 per cent. Its current-account deficit reached an estimated 36.1 per cent of GDP, reflecting strong import dependence and weak exports. The World Bank also identifies unreliable electricity, limited access to finance and widespread informality as constraints on private investment.

Afghanistan therefore demonstrates that development can be constrained by both too much debt and too little capital. Its challenge is to restore the conditions under which domestic and foreign private investment can contribute to productive capacity.

Uneven FDI Flows Across South Asia

The FDI picture reinforces these structural differences. South Asia is not simply experiencing a collapse of FDI. UNCTAD reports that India recorded a 44 per cent increase in FDI inflows in 2025, helping drive growth in South Asian investment. At the same time, UNCTAD emphasises that FDI remains increasingly concentrated across economies and sectors.

India's ability to attract FDI reflects several structural advantages: its enormous domestic market, relatively diversified economy, expanding digital and services sectors, large skilled workforce, growing manufacturing capabilities and increasing integration into global supply chains. The scale of the Indian market also allows multinational companies to invest for both exports and domestic sales.

These advantages are not easily replicated by smaller South Asian economies.

Bangladesh possesses a substantial labour-intensive manufacturing base, particularly in garments, but investment conditions have been constrained by weak financial institutions, infrastructure bottlenecks, regulatory uncertainty and limited diversification. The World Bank identifies subdued private investment and a stressed banking sector among the country's major constraints.

Pakistan faces a different combination of problems. Political and macroeconomic uncertainty, recurrent foreign-exchange shortages, energy constraints and a relatively narrow export structure have weakened the incentives for long-term foreign investment. Investors are naturally more cautious when exchange-rate instability and external financing problems can affect their ability to repatriate profits or import inputs.

Nepal and Bhutan face the disadvantages of small markets and difficult geography. The World Bank notes that manufacturing accounts for only about 4 per cent of value added in Nepal and 8 per cent in Bhutan, compared with 14 per cent for emerging-market and developing economies overall. Infrastructure and logistics constraints further reduce their attractiveness for large-scale manufacturing investment.

The Maldives faces an even more specialised investment structure. Tourism dominates the economy; so FDI naturally concentrates in hotels, resorts and related infrastructure rather than a diversified manufacturing base.

Afghanistan faces much more fundamental constraints. Political and institutional uncertainty, limited access to international finance, weak infrastructure and restrictions affecting economic activity make conventional FDI extremely difficult. The result is a shortage of investment rather than an excessive accumulation of foreign debt.

These differences demonstrate why FDI should not be treated as simply a function of tax incentives. Investors look for market size, political and macroeconomic stability, infrastructure, skilled labour, access to finance, predictable regulation and integration into international markets. The World Bank's latest South Asia Economic Update identifies infrastructure, skills, business conditions and regulatory predictability as central to attracting private capital and creating jobs.

From Debt Dependence to Productive Capital

The central lesson is therefore not that South Asia has too much debt or too little FDI. It is that countries differ greatly in their ability to convert external finance into productive capacity. Debt becomes unsustainable when it finances consumption or recurrent expenditure without generating future income. FDI becomes transformative when it creates productive assets, employment, exports, skills and links with domestic firms. Remittances provide essential foreign exchange and household income, but they cannot substitute for investment in domestic productive capacity.

This is particularly important because remittances have become an unusually large source of external finance for South Asia. For countries such as Nepal and Bangladesh, they provide a crucial cushion against external shocks. But a development model in which workers migrate because domestic employment is inadequate and then send income home to support domestic consumption cannot indefinitely substitute for creating productive employment at home.

The region therefore needs a shift in emphasis from simply obtaining external finance towards improving the quality of finance.

For Pakistan and Sri Lanka, this means rebuilding export capacity and reducing debt-service pressures. For Bangladesh, it means strengthening fiscal institutions, financial-sector stability and investment conditions so that its manufacturing success can broaden beyond garments. For Nepal, it means converting remittance-supported stability into productive investment. Bhutan needs to ensure that hydropower borrowing generates sufficient returns while diversification reduces concentration risk. The Maldives needs to reconcile ambitious infrastructure investment with the vulnerability of a tourism-dependent economy. Afghanistan requires the restoration of conditions conducive to productive private investment. India has the opportunity to use its scale, domestic savings and expanding FDI to deepen its participation in global value chains.

The broader regional challenge is also becoming more difficult because global FDI itself is becoming concentrated. UNCTAD reports that the world's largest host economies now absorb a very large share of global investment and that much recent growth has been concentrated in strategic sectors such as digital infrastructure.

South Asia therefore has to compete for capital not merely by offering incentives but by improving the fundamentals that make investment productive. Better infrastructure, reliable energy, skilled workers, efficient ports and logistics, predictable regulation and access to large markets matter more than isolated investment subsidies.

The region's development challenge can consequently be understood as a transition from external finance as a means of closing immediate financing gaps to external finance as an instrument for expanding future productive capacity.

That distinction is central to the debate now emerging internationally over debt and development finance. The objective cannot simply be to replace aid with borrowing, or borrowing with FDI. The objective must be to construct an economic system in which domestic savings, public investment, FDI, trade and remittances reinforce one another.

The Decisive Issue

Ultimately, debt sustainability depends on the capacity to generate income and foreign exchange. FDI matters because it can expand that capacity. Trade matters because it creates export earnings. Domestic revenue matters because it gives governments the fiscal space to invest without excessive borrowing. Employment matters because it converts economic growth into a broader domestic income base.

For South Asia, therefore, the decisive issue is not the amount of capital crossing its borders but what that capital leaves behind. If it leaves behind productive infrastructure, competitive enterprises, skills, technology, exports and employment, external finance becomes a foundation for development. If it merely finances consumption, recurring deficits or debt repayment, it can postpone rather than resolve the underlying problem.

The next phase of South Asian development will depend on making that transition successfully.

(The writer is a retired Special Secretary, Government of India, and a commentator on financial, geoeconomic and regional issues. The views expressed are personal. He can be reached at ppmitra56@gmail.com.)