"If it does not, treasuries will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable," said Urjit Patel, in an article written to Financial Times.
Given the rapid rise in the size of the US deficit, the US Federal Reserve must slow its plans to shrink the balance sheet, said RBI governor Urjit Patel.
"If it does not, treasuries will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable," he added.
In an article written in the Financial Times, he said the bank's flexible approach has played a pivotal role in maintaining global financial stability.
"Global spillovers did not manifest themselves until October of last year. But they have been playing out vividly since the Fed started shrinking its balance sheet. This is because the Fed has not adjusted to, or even explicitly recognised, the previously unexpected rise in US government debt issuance. It must now do so," he said.
The good news is that there is an option available to the Fed that does not require it to change the overall policy direction, he said.
"It can simply recalibrate its normalisation plan, adjusting for the impact of the deficit. A rough rule of thumb would be to reduce the pace of its balance-sheet contraction by enough to damp significantly, if not fully offset, the shortage of dollar liquidity caused by higher US government borrowing," he said.
Such a move would help smooth the impact on emerging markets and limit effects on global growth through the supply chains that span both developed and emerging economies, he said, adding, otherwise, the possibility will increase of a "sudden stop" for the global economic recovery.
It may hurt the US economy as circumstances have changed, he said.
Source: Financial Times