The wave of currency depreciation that battered Indonesia’s foreign exchange market throughout April and May 2026 has pushed the rupiah to record lows, dangerously close to a new psychological threshold of 18,000 against the US dollar.
When the currency broke past 17,000 in early April, it stoked painful public memories of the 1997–1998 Asian financial crisis and the rupiah’s collapse. The crisis exposed deep structural problems at the core of Indonesia’s economy, and the general public was forced to pay the price.
In theory, exchange rates in the long run are largely determined by purchasing power parity, a principle that accounts for inflation differentials between countries. Judged by historical inflation gaps between Indonesia and the United States, the rupiah’s new slippage could fall within what could be considered a reasonable long-term adjustment.
Yet the exceptionally sharp slide over the past two months points to something far more severe: an extreme overshooting phenomenon. The currency’s collapse no longer reflects underlying purchasing power fundamentals, but rather a market disequilibrium driven by panic, massive capital flight and an acute shortage of dollar liquidity in the domestic spot market.
The budding crisis has been aggravated by Bank Indonesia’s delayed response to mounting market stress. The central bank had become overly comforted by moderating domestic inflation, which fell to 2.42% in April 2026.
That decline created the misleading impression that monetary tightening was not urgent, even though the softer inflation figures were largely temporary, driven by post-Eid seasonal effects and the annual harvest cycle.
Keen to maintain strong economic growth and credit expansion, Bank Indonesia postponed defensive action and kept benchmark interest rates unchanged for seven consecutive months through April 2026. Before eventually raising rates, the central bank attempted to stabilize the rupiah through various non-interest-rate instruments.
That included aggressive triple-intervention measures in the foreign exchange market, tightened rules on foreign currency conversion without underlying transactions and the issuance of short-term monetary securities.
Yet the policy mix failed to halt the rupiah’s decline. Under the logic of monetary quantity theory, absorbing dollars from the market can only be effective if accompanied by tighter control of the domestic money supply.
Instead, Bank Indonesia continued to allow domestic liquidity creation to remain loose, with base money growth remaining in double-digit territory in an effort to sustain economic expansion. Combined with the rapid growth of digital transactions that accelerated money circulation across the economy, this abundance of cheap rupiah liquidity created a perverse incentive.
Market participants borrowed cheaply in local currency, converted the funds into dollars and moved capital offshore in pursuit of higher yields abroad.
Interest rate paradox
As the rupiah weakened further toward 17,700 per dollar in mid-May, Bank Indonesia caught markets off guard by finally making an aggressive move, raising its benchmark rate by 50 basis points to 5.25 percent.
The dramatic hike was designed to create a shock effect at a time when foreign exchange reserves were under pressure and geopolitical tensions in the Middle East were disrupting trade flows through the Strait of Hormuz. Indonesia, despite rich stores of oil and gas, is a net energy importer, adding to the strain on the rupiah.
Global crude oil prices surged toward $96 per barrel, while US Treasury yields climbed to 4.66%, sending powerful tremors across emerging-market financial systems.Yet instead of calming investors, Bank Indonesia’s rate hike triggered more disorientation in domestic financial markets.
Indonesia’s stock market plunged more than 2% almost immediately amid fears of rising corporate financing costs, while government bond prices also came under intense pressure.This is where Indonesia’s monetary paradox is becoming starkly apparent.
In theory, according to the uncovered interest parity principle, higher domestic interest rates should strengthen a currency by making local assets more attractive to foreign investors. But such textbook assumptions often break down during periods of extreme market anxiety.
The 50-basis-point increase proved insufficient to offset expectations of further rupiah depreciation and the rapidly rising risk premium attached to Indonesian assets. Global investors chose to ignore the additional yield and instead fled to safer overseas assets amid growing perceptions of panic in the Indonesian government.
Market pessimism gained further justification when Indonesia’s external fundamentals deteriorated sharply. The country’s current account deficit in the first quarter of 2026 widened to $4 billion, equivalent to 1.1% of GDP, marking the widest deficit since the end of the pandemic.
At the same time, the capital account deficit deepened as large volumes of private-sector external debt matured. Indonesia’s overall balance of payments recorded a historic deficit of $9.1 billion, the worst quarterly figure in more than two decades.
The figures sent a clear message to global fund managers: Indonesia is facing a structural shortage of dollars.
Regulatory shock
At a moment when external conditions were already fragile, poorly calibrated domestic regulations have added another blow.
The government’s decision to introduce new rules governing the repatriation of export earnings under Government Regulation No. 21 of 2026, scheduled to take effect on June 1, has triggered widespread anxiety among exporters. The regulation requires non-oil-and-gas exporters to repatriate and retain all export earnings within state-owned banks for a minimum of 12 months.
At the same time, the establishment of new entities such as PT Danantara Sumberdaya Indonesia, a sovereign fund created under the Prabowo administration known generally as just Danantara, as the sole strategic commodity export management agency, has added more uncertainty to the business climate.
Rather than strengthening foreign exchange reserves, the state interventions have sparked a private-sector backlash. Exporters say the requirement to immobilize funds for a full year is a major disruption to their corporate cash flow management, particularly for firms dependent on rapid liquidity turnover to sustain daily operations.
Facing the prospect of their funds becoming trapped once the regulation came into force, exporters adopted defensive strategies by withholding dollar-to-rupiah conversions and moving foreign currency liquidity into offshore accounts before the policy deadline.
The result was a severe drying up of dollar supply in the domestic foreign exchange market, parching the rupiah of one of its natural stabilizers in the spot market. The dollar shortage then collided with seasonal corporate demand pressures.
Every May, Indonesian corporations typically require substantial dollar purchases to pay dividends to foreign shareholders and service maturing external debt obligations. Because these payments are legally binding, the demand for foreign currency is highly inelastic, meaning companies must acquire dollars regardless of the prevailing price.
When this surge in demand collided with a supply freeze driven by regulatory trepidation, the price of dollars in local markets soared, dragging the rupiah down to 17,900 per greenback by the end of May.
Path to stabilization
Given the complexity of the crisis, stabilizing the national currency can no longer rely solely on short-term measures such as raising interest rates. It is fundamentally contradictory for the central bank to tighten rates on one side while simultaneously allowing domestic liquidity to remain excessively loose in pursuit of growth.
Domestic money creation must be tightened in a measured but credible manner so that liquidity conditions align with the high-interest-rate regime. By genuinely reducing the supply of rupiah circulating in the financial system, the currency would gain stronger support through the natural scarcity of domestic liquidity.
The government should also rethink the operational framework for retaining export earnings. The requirement to retain 100% of export proceeds for 12 full months should be replaced with a more business-friendly mechanism, such as a tiered system based on company size and shorter holding periods.
To bridge exporter liquidity needs while their dollar deposits remain parked domestically, Bank Indonesia and the banking sector should provide efficient liquidity swap facilities. Under such a mechanism, exporters could use their dollar deposits as collateral to obtain low-interest rupiah financing for operational expenses, reducing incentives to hoard foreign currency offshore.
The government would also be wise to provide much greater legal clarity and communication transparency regarding the operational structure of the Danantara wealth fund to avoid market misinterpretation and investor panic.
At the same time, coordination between monetary and fiscal authorities must be strengthened to prevent the emergence of twin deficits that could undermine national economic resilience. State spending must also be managed with far greater discipline, avoiding wasteful expenditures on non-productive programs at a time when commodity-related revenues are weakening.
Through a stricter macroprudential policy mix aimed at strengthening export-oriented industries and import substitution, Indonesia can gradually repair the structural weaknesses in its current account balance rather than remaining dangerously dependent on volatile short-term capital inflows that disappear whenever global shocks intensify.
Only then will markets stop dumping the rupiah.
Ronny P Sasmita (PhD) is senior analyst at Indonesia Strategic and Economic Action Institution, a Jakarta-based think tank.
