diff --git a/Extension/CHANGELOG.md b/Extension/CHANGELOG.md
index b8c8b62db..dfdaabcdc 100644
--- a/Extension/CHANGELOG.md
+++ b/Extension/CHANGELOG.md
@@ -15,6 +15,7 @@
 * Reduce CPU usage when resolving headers in large Windows workspaces.
 
 ### Bug Fixes
+* Fix `${VAR}` interpolation in `.env` files used by `envFile`: references to variables defined earlier in the same file (or in the OS environment) are now resolved. [#13781](https://github.com/microsoft/vscode-cpptools/issues/13781)
 * Fix 'Go to Declaration' and 'Go to Definition' returning the current location instead of an available counterpart. [#14509](https://github.com/microsoft/vscode-cpptools/issues/14509)
 * Update MIEngine to fix debugger failures with synthetic GDB stack frames. [#14741](https://github.com/microsoft/vscode-cpptools/issues/14741)
   * Thanks for the contribution. [@tzcnt](https://github.com/tzcnt) [PR MIEngine#1605](https://github.com/microsoft/MIEngine/pull/1605)
diff --git a/Extension/src/Debugger/ParsedEnvironmentFile.ts b/Extension/src/Debugger/ParsedEnvironmentFile.ts
index 9018a540b..311fda21b 100644
--- a/Extension/src/Debugger/ParsedEnvironmentFile.ts
+++ b/Extension/src/Debugger/ParsedEnvironmentFile.ts
@@ -59,6 +59,17 @@ export class ParsedEnvironmentFile {
 
                 value = value.replace(/(^['"]|['"]$)/g, "");
 
+                // Resolve ${VAR} references against the variables defined so far in the file
+                // (and the process environment), following the dotenv interpolation rules.
+                // A reference to a name we don't know is left as-is instead of being dropped.
+                value = value.replace(/\$\{([\w\.\-]+)\}/g, (full: string, name: string): string => {
+                    if (env.has(name)) {
+                        return env.get(name);
+                    }
+                    const processValue: string | undefined = process.env[name];
+                    return processValue !== undefined ? processValue : full;
+                });
+
                 env.set(key, value);
             } else {
                 // Blank lines and lines starting with # are no parse errors
diff --git a/Extension/test/scenarios/SingleRootProject/tests/ParsedEnvironmentFile.test.ts b/Extension/test/scenarios/SingleRootProject/tests/ParsedEnvironmentFile.test.ts
index a107971ce..6e8abff01 100644
--- a/Extension/test/scenarios/SingleRootProject/tests/ParsedEnvironmentFile.test.ts
+++ b/Extension/test/scenarios/SingleRootProject/tests/ParsedEnvironmentFile.test.ts
@@ -100,4 +100,31 @@ MyName2=Value2
         assertEnvironmentEqual(result.Env, "MyName1", "Value1");
         assertEnvironmentEqual(result.Env, "MyName2", "Value2");
     });
+
+    test("Resolve a reference to a variable defined earlier in the file", () => {
+        const content: string = `USER=admin
+EMAIL=\${USER}@example.org`;
+        const result: ParsedEnvironmentFile = ParsedEnvironmentFile.CreateFromContent(content, "TestEnvFileName", []);
+
+        assert(!result.Warning, `Failed to assert that Warning was empty: ${result.Warning}`);
+        assertEnvironmentEqual(result.Env, "USER", "admin");
+        assertEnvironmentEqual(result.Env, "EMAIL", "admin@example.org");
+    });
+
+    test("Resolve a reference from the initial environment", () => {
+        const initialEnv: Environment[] = [{ name: "USER", value: "admin" }];
+        const content: string = `EMAIL=\${USER}@example.org`;
+        const result: ParsedEnvironmentFile = ParsedEnvironmentFile.CreateFromContent(content, "TestEnvFileName", initialEnv);
+
+        assert(!result.Warning, `Failed to assert that Warning was empty: ${result.Warning}`);
+        assertEnvironmentEqual(result.Env, "EMAIL", "admin@example.org");
+    });
+
+    test("Leave an unknown reference untouched", () => {
+        const content: string = `EMAIL=\${UNKNOWN_USER}@example.org`;
+        const result: ParsedEnvironmentFile = ParsedEnvironmentFile.CreateFromContent(content, "TestEnvFileName", []);
+
+        assert(!result.Warning, `Failed to assert that Warning was empty: ${result.Warning}`);
+        assertEnvironmentEqual(result.Env, "EMAIL", "${UNKNOWN_USER}@example.org");
+    });
 });