Currency swap agreement between India and UAE in Legal terms

First, we will try to understand what currency swap agreement is.

It’s an agreement to between two countries, here it’s between India and UAE to exchange good and services using their own local currency. Instead of using third currency like US dollar

Here the agreement happens between central banks of two countries India and UAE. Central bank of India will give prescribed amount of loan to UAE and Central bank of UAE will give prescribed amount of loan to India. The rate will be decided according to the current exchange rate.

In case of UAE and India. UAE central bank provides 2 billion dirhams to India and Indian central bank provides 35 billion rupees to UAE.

Which later both the countries repay the amount with agreed exchange rate. In return, there will be a swap rate to be decided by the two countries. Normally, they will be linked to London inter-bank rate, called Libor. 

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After this agreement both the countries do not require US dollars to trade goods and between both the countries.

It also helps to bring the stability of local currency by reducing the impact of volatility in exchange rates due to dependency on third currency like US dollar.

This will also help build stronger trade relations between two countries.

Little more info on bilateral trade between India and UAE from ET:

“India and the UAE bilateral trade stands at $52 billion in 2017, with non-oil trade accounting for $34 billion. India’s FDI into the UAE last year was $6.6 billion while the UAE’s investment in India stood at $5.8 billion. The two countries are also cooperating in a big way in the energy sector. “

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This agreement basically a contract between 2 countries. So as in contract this agreement will also have following risks involved.

1. The credit risk: If the value of the swap for one country becomes negative so that, the loan amount cannot be funded. In this scenario the other country will be concerned that country with negative swap value might not fulfill the obligations.

In such Scenario there might be breach of contract due to obligations not fulfilled during performance. There must be proper jurisdiction chosen agreed by both parties.

This cannot be considered as Impossibility of Performance as Commercial impossibility and Difficulty of performance cannot be considered as excuse.

• This agreement is always a valid contract as it is always signed between competent person and with free consent between both the countries.
• This agreement is always a valid contract as there will always be consideration of benefit of trade between both the countries and there is not unlawful object involved in it.
• This agreement can be discharged in following situations:
  • Novation: A new agreement is substituted (example: with new exchange rate/swap rates agreed by both the parties)
  • Rescission: Cancellation of all or some of the terms in the agreement agreed between parties
  • Alteration: one or more terms can be altered in the agreement with consent of both the parties.
  • Remission: Accepting lesser fulfilment of the promise agreed between parties.

There are other risks like reputation risk if one of the parties’ mis-sell swap or could fulfill obligations or fined by regulators.

Since, these are macro-economic factors. Where if swap of currencies between countries makes both the countries bound to fulfill their obligations even if there is better opportunity available in the market or they can get the benefit of stability if there is high volatility in the market. Will usually drill down to the individual. Will give you an example.

If Indian imports are more than the exports and oil is the major the import. Say there is no swap agreement and oil are traded between India and UAE through third currency US dollars. Then if there is increase in US 1 dollar per barrel to the Indian rupee. Then the importer has shell out that extra dollar to UAE and pass the cost on the consumer. If there is predefined swap agreement. Then fluctuation in dollar price will not affect our oil imports from UAE.