Central banking is a profitable business because normally profits only move up. The profit ratios or rather surpluses tend to be healthy, as most activity is well-defined, and as they normally end up lending to the banking system, there is money to be made. This has also been the case in India, with the major beneficiary being the government when the surpluses are transferred to budget accounts. RBI will be transferring a lower quantum of money to the government this year: Rs 30,659 crore compared with Rs 65,876 crore last year. What does this imply? The difference of around Rs 35,000 crore is significant as it a major constituent of budgetary numbers. Two issues come to the forefront. The first relates to the reason why the surplus is lower. As the surplus is a result of the difference between income and expenditure, either the income has fallen short or expenditure has risen. Income is down as it has been selling its investments in G-Secs through OMOs to banks to mop up excess liquidity, which would have otherwise earned interest for the central bank. There have been OMOs of Rs 30,000 crore this year, and at an interest rate of even 6.5%, there will be income foregone by RBI in the coming months. Expenditure would be higher since RBI has gone in for LAF on the reverse repo front. On account of demonetisation, there was surplus liquidity with banks, which has only increased over time. To absorb the same, RBI has been going in for reverse repo, where an interest rate of around 6% is paid. As the amount has varied on a daily basis, given that an average of `3-4 lakh crore has been involved through the daily and term reverse repo, the cost incurred for the half year ending June 2017 would be in the region of `9,000-12,000 crore. Therefore, prima facie, it appears that demonetisation has impacted the income expenditure statement of RBI. In the last two years, RBI has transferred `65,000 crore to the government as it has made more money than its expenditure. The shortfall of Rs 35,000 crore for this year upsets the fiscal maths. This component comes in as non-tax revenue of the government, which was to include Rs 75,000 crore as transfers from RBI, banks and FIs. RBI was to provide the bulk of this amount. Now with a lower transfer taking place, the shortfall will get reflected in this account. PSBs will definitely not be able to compensate for this shortfall as they are already in the red. Hence, there could be a deficit to the extent of Rs 35000 crore on this score, with other things being constant. What does this mean? Several possibilities are there. One is where income increases from other sources. On this side, there is some hope that direct taxes will increase due to better reporting and more people showing up on the tax net. But it is not clear as yet whether or not this has already been buffered in the calculation of income tax collection, as at the time of the Budget it was mentioned that demonetisation would lead to more tax assesses. How about indirect taxes? Here there would, at best, be a shoulder shrug because demonetisation has been followed up with GST, which, though essential and progressive, has come at a time when the economy has slowed down and is still to recover from demonetisation. Hence, one is again not sure of the impact on revenue. While GST is supposed to be revenue-neutral, there would be substantial reconciliation with state accounts, and to this extent there may be limited upward buoyancy. This has not been considered in the budget numbers for both the states and the Centre, and would be a black box today. On the other side, disinvestment targets are always overstated in budgets because it appears to be a balancing item. Hence, a slippage is possible here too, of around Rs 20,000 crore, going by past experience. Put together, there is reason to believe that there could be a shortfall of around Rs 50,000 crore this year in the deficit, which can push up the fiscal deficit ratio by 0.3-0.4% of GDP with other things remaining constant. But if the government has to adhere to the fiscal deficit target, then expenditure cuts would be necessary and the axe would fall more likely on capital expenditure. This can upset, at one stroke, the midterm targets released by the government earlier hence pose a challenge. RBI is still to present its accounts, which would provide a perspective on the effects of demonetisation. The currency replaced will be known as the currency liability number is revealed. The same will go with the printing cost of currency, as it does appear that RBI has added substantially to the currency in circulation six months has after the scheme came to an end. One guess is that with new currency of Rs 6 lakh crore being added since January, there would be printing of at least 1,500 crore currency pieces (in denomination of Rs 100, Rs 500 and Rs 2,000), which would add to the expenditure depending on the per-piece cost involved. This would also be the first ostensible cost that would have to be incurred by the government in terms of lower non-tax revenue from RBI. Curiously, the government has been impervious to demonetisation in monetary terms as the players on stage during this phase were RBI, banks and households. If the government was right in its assumption of more taxpayers entering the stream, then there would be some compensation. Else, a choice has to be made between exceeding the fiscal deficit and curtailing capex. Either way, the economy would be at a disadvantage. This was one possibility of the impact of demonetisation that was not quite visualised, and has entered through the back door.