"A couple of people jumped from windows," a member of staff at the hostel told AAP.
"No-one was injured, there was some people taken away with smoke inhalation but there was nothing serious."
A NSW Fire and Rescue spokesman added: "The building was heavily smoke-logged and a number of people were at windows.
"There was obviously a great deal of concern from the occupants."
The cause of the fire is suspicious and police have launched an investigation.
Shelby Murphy, 20, from Seattle, told Sydney's Daily Telegraph that she jumped from a second floor balcony to escape the smoke.
Another backpacker, Jack Hardy from England, told the newspaper: "Smoke filled the corridors. You couldn't see the numbers on the doors.
"I woke up to the alarms going off and people banging on our door."
- AAP