The Iran war is hitting the Indo-Pacific’s most fragile economies hard. The shock is travelling through multiple channels at once: energy, food, financial stress, and political instability.
South Asia is the most exposed. Pakistan, Bangladesh and Sri Lanka import nearly all their crude oil from the Gulf and depend on oil and gas for more than half of their energy mix. All three hold less than a month in fuel reserves. In response, governments have resorted to extreme measures: four-day working weeks, fuel rationing at petrol stations, and rolling blackouts. Others are reminiscent of the pandemic: return to remote schooling and work-from-home orders.
The Philippines is as dependent on crude oil as South Asia and has followed suit in enforcing similar restrictions. By contrast, smaller players like Cambodia and Laos lack domestic refining capacity and do not directly import crude oil from the Gulf. However, they are more exposed due to their reliance on refined oil imports from neighbouring countries. Laos relies on Thailand for almost all of its refined oil imports, Cambodia has turned to Malaysia and Singapore after Vietnam and China implemented export restrictions.
Food security is another major pressure point. Roughly a third of the raw materials for global fertiliser production passes through the Strait of Hormuz. More expensive fertiliser means lower yields and higher food prices. In Pakistan, Nepal and Bangladesh more than 30% of the population was already facing moderate or severe food insecurity before the war. The same holds for Cambodia and Laos. The World Food Program estimates an additional 9.5 million people in Asia will face acute food insecurity this year if the war continues.
A prolonged crisis threatens not just reduced transfers but mass layoffs and migrant returns.
The International Monetary Fund (IMF) expects slower global growth over the next two years. A slowing world economy will weigh on national incomes through exports and tourism receipts. For Southeast Asian economies, exports are a major source of growth. In Thailand and Vietnam exports are equal to 70% and 90% of GDP. A slowdown in demand from major partners will be felt in jobs and growth.
Fiscal resilience is uneven across the region. Indonesia and India have absorbed the initial shock by leaning harder on fuel and fertiliser subsidies. But this comes at a cost. Indonesia must choose between breaching its 3% deficit ceiling and passing prices through to consumers, history has proven the latter especially unpopular. India’s fertiliser subsidy bill will increase by 20%, reaching almost US$20 billion. Both policies are adding to the fiscal burden. Debt-stricken economies such as Pakistan, Sri Lanka, Bangladesh and Laos have less room; they are bound by IMF or bilateral programs that require fiscal tightening and removing fuel subsidies – economically necessary but politically destabilising.
External vulnerabilities compound the damage. Central bank reserves across indebted economies cover less than the standard three months of imports, leaving little buffer against a sustained rise in oil prices. Exchange rate depreciation is pushing up external debt service costs. Pakistan has already signed a US$3 billion bailout with Saudi Arabia, after the UAE refused to roll over US$3.5 billion of debt. Remittances are also in danger. For Nepal and Pakistan remittances from the Gulf make up 8% and 5% of GDP respectively. A prolonged crisis threatens not just reduced transfers but mass layoffs and migrant returns. The countries with the least fiscal room are also the most externally exposed, and the two vulnerabilities reinforce each other.
Political unrest is building. Protests have flared in Jakarta, Manila and other capitals throughout the region. Rising food and fuel costs and slowing economic growth are driving public dissatisfaction. And political stability is low among the most-exposed economies – the Philippines and Pakistan in particular. Governments have every incentive to keep fuel prices low even when doing so damages budgets. The trade-off, between short-term political survival and long-term economic credibility is emerging as a defining feature of government response across the region.
In a region where fiscal space is shrinking and political pressure is rising, social protection could be a stabilising force. Yet provision across the Indo-Pacific is uneven. South Asia – India, Pakistan, Bangladesh and Sri Lanka – spend the least, with social protection budgets that are a small fraction of GDP. The Philippines does better, having built out conditional cash transfers over the past decade, though coverage can be better. At the other end of the spectrum, Vietnam and China devote larger shares of GDP to social protection, giving them more room to absorb shocks without resorting to subsidies. Targeted protection can reach the households that feel the shock first at a fraction of the cost of universal subsidies. But the countries that most need social protection are those whose budgets do the least to provide it.
It is easy to overlook the Pacific Islands, given their small size and limited data availability. On energy, net oil and gas imports already account for 5–15% of GDP across the region – a level of exposure unmatched in the Asia-Pacific. Fiji’s refined fuel import bill could reach nearly three times its annual healthcare budget, while Vanuatu’s could surge by the equivalent of 11% of GDP. The shock has already prompted emergency measures, with Tuvalu and the Marshall Islands declaring states of emergency. Tourism is another downside risk for the Pacific Islands, where receipts make up the bulk of foreign income in Palau, Cook Islands, and Fiji. Lost tourism revenue is slow to return, as the pandemic demonstrated.
The Pacific is just as dependent on food imports, with an average of 60% of all food imported. For some like the Cook Islands this figure jumps to 92%. As fuel and fertiliser prices climb, basic food becomes inaccessible for poor households. Without support from development partners, a sustained fuel and food price shock will throw these small island states off their development course.
The Indo-Pacific’s most fragile economies are absorbing multiple shocks at once, with economies and societies still scarred from previous crises. If the Strait stays closed through 2026, the question is not just which economies can weather the shock, but how much of the region’s development progress will have to be rebuilt.
