This observational study aimed to describe immunopathogenesis and treatment outcomes in children with and without severe acute malnutrition (SAM) and HIV-infection. We studied markers of microbial translocation (16sDNA), intestinal damage (iFABP), monocyte activation (sCD14), T-cell activation (CD38, HLA-DR) and immune exhaustion (PD1) in 32 HIV-infected children with and 41 HIV-infected children without SAM prior to initiation of antiretroviral therapy (ART) and cross-sectionally compared these children to 15 HIV-uninfected children with and 19 HIV-uninfected children without SAM. We then prospectively measured these markers and correlated them to treatment outcomes in the HIV-infected children at 48 weeks following initiation of ART. Plasma levels of 16sDNA, iFABP and sCD14 were measured by quantitative real time PCR, ELISA and Luminex, respectively. T cell phenotype markers were measured by flow cytometry. Multiple regression analysis was performed using generalized linear models (GLMs) and the least absolute shrinkage and selection operator (LASSO) approach for variable selection. Microbial translocation, T cell activation and exhaustion were increased in HIV-uninfected children with SAM compared to HIV-uninfected children without SAM. In HIV-infected children microbial translocation, immune activation, and exhaustion was strongly increased but did not differ by SAM-status. SAM was associated with increased mortality rates early after ART initiation. Malnutrition, age, microbial translocation, monocyte, and CD8 T cell activation were independently associated with decreased rates of CD4% immune recovery after 48 weeks of ART. SAM is associated with increased microbial translocation, immune activation, and immune exhaustion in HIV-uninfected children and with worse prognosis and impaired immune recovery in HIV-infected children on ART.