Mumbai: The US Federal Reserve must slow down the pace of trimming its balance sheet in order to avoid a crisis in the dollar bond market, RBI governor Urjit Patel said in an opinion piece in the Financial Times.
“Given the rapid rise in the size of the US deficit, the Fed must respond by slowing plans to shrink its balance sheet. 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," Patel wrote in the piece published on Sunday.
Patel argued in the piece, titled Emerging markets face a dollar double whammy, that the current dollar liquidity shortage is not due to the Fed’s move on interest rates, which has been rising since December 2016.
“The upheaval stems from the coincidence of two significant events: the Fed’s long-awaited moves to trim its balance sheet and a substantial increase in issuing US Treasuries to pay for tax cuts," he wrote.
Patel also said that while the Fed had prepared the market for a gradual unwinding of its balance sheet, the high US government borrowing has taken the market by surprise.
“Dollar funding has evaporated, notably from sovereign debt markets. Emerging markets have witnessed a sharp reversal of foreign capital flows over the past six weeks, often exceeding $5 billion a week. As a result, emerging market bonds and currencies have fallen in value," he said.
Patel’s article comes ahead of the 3-day Monetary Policy Committee meeting which began on Monday. According to a survey conducted by Mint, the MPC is expected to keep the key policy rate unchanged despite the spike in crude oil prices and rising inflation.