Sheltered: Implications of geoeconomic fragmentation for South Asia

The global economy is fragmenting along geopolitical lines. Many emerging market and developing economies (EMDEs), including those in South Asia, are navigating geoeconomic vulnerabilities while also aiming to benefit from the reshaping of global value chains. How vulnerable is South Asia to geopolitical risk? What policies could help countries within the region to thrive amid diversifying international trade flows? The World Bank’s latest South Asia Development Update delves into these questions and examines the implications of geoeconomic fragmentation for South Asia.

Sheltered from geopolitical shocks

South Asian countries’ geopolitical stances, proxied by their UN voting patterns, are broadly in line with those of most EMDEs (figure A). By this measure at least, South Asian countries are geopolitically more closely aligned with China than with their main export destinations and largest FDI sources in the United States and Europe.

However, South Asian countries’ lack of openness to global trade and investment insulates them from external shocks, including geopolitical ones. South Asian countries are among the quartile of EMDEs that are the least open to global trade and investment (figures B-C). 

Sources: Aiyar and Ohnsorge (2024); Bailey, Strezhnev, and Voeten (2017); IMF Balance of Payments and International Investment Position Statistics (database); World Development Indicators (database); World Bank. Note: BGD = Bangladesh; BTN = Bhutan; EMDEs = emerging market and developing economies; FDI = foreign direct investment; IND = India; LKA = Sri Lanka; MDV = Maldives; NPL = Nepal; PAK = Pakistan. A. Figure is based on the ideal point index of country voting patterns in the UN General Assembly. The index ranges from -2.5 to +2.5 points. Other EMDEs comprise 137 economies. B. Trade is defined as the sum of goods and services exports and imports. Maldives uses 2022 data. B.C. Red shades denote interquartile ranges for other EMDEs, comprising 72 (B) and 67 economies (C). Gray shades denote interquartile ranges for small state EMDEs (as defined by World Bank 2024), comprising 13 (B) and 8 economies (C). D. Geoeconomic connectedness (GeoC index) measures the trade or liability-weighted standard deviation of the geopolitical distances to export destinations or creditors. South Asia aggregate reports the GDP-weighted average. Latest data are 2023 for trade (except 2022 for Bhutan) and 2022 for FDI and portfolio investment. Sample includes 127 other EMDEs.

Limited gains from diverse ties

South Asia’s lack of openness is not only protective. It also limits the region’s ability to leverage its geopolitically diverse ties and take advantage of the ongoing reshaping of global supply chains. South Asian countries are among the EMDEs with the most geopolitically diverse export markets, FDI sources, and portfolio investment—as captured by the geoeconomic connectedness index (figure D). Since 2016, India, Pakistan, Sri Lanka and Bhutan have further increased the diversity of their export destinations and sources of FDI. However, their lack of economic openness hinders these countries from fully realizing the potential benefits.

Policies to benefit from geoeconomic fragmentation

To open South Asian economies to global trade and investment, import tariffs need to be lowered, restrictions on FDI eased, infrastructure and logistics improved, and financial markets deepened. Joining a wide range of different trade agreements can help maintain a diverse set of trading partners and creditors and mitigate vulnerabilities to external shocks. The potential magnitude of gains is large. Cross-country evidence suggests that export connectedness might have been on par with Malaysia and Indonesia if South Asian countries adopted the logistics performance and reduced tariffs to those of in the best-performing EMDE quartile.