The rupiah has had a difficult year. By January 2026, it had already reached record lows against the US dollar, even as the dollar itself was weakening. Concerns over Indonesia’s widening fiscal deficit, questions surrounding Bank Indonesia’s independence, and persistent foreign capital outflows had raised the premium investors demanded to hold Indonesian assets. Not to mention the global uncertainty from the war in the Middle East, higher oil prices, and expectations of tighter US monetary policy added further pressure.
These explanations are well known in the field of economics. Exchange rates should respond to differences in inflation, interest rates, monetary policy, trade balances and expectations about future economic conditions. Higher US interest rates, for example, make dollar assets relatively more attractive. A worsening current account increases demand for foreign currency. Fiscal uncertainty could also similarly increase the risk premium on domestic assets.
There is nothing mysterious about the rupiah facing depreciation pressure.
The more intriguing question is that why has the movements been so sharp? What might be the defining cause?
Indonesia’s fundamentals hardly resembled those of an economy in crisis. Inflation remained within Bank Indonesia’s target range, while foreign-exchange reserves stood at US$145.6 billion in June — equivalent to around 5.5 months of imports and comfortably above conventional adequacy standards. Yet the rupiah remained unusually sensitive to shifts in global sentiment.
One episode makes this tension particularly clear.
On 27 January, MSCI announced an interim freeze on several upward adjustments to Indonesian securities, citing opacity in shareholding structures and concerns over coordinated trading. It warned that insufficient progress could eventually lead to lower Indonesian weights in MSCI indexes or even reconsideration of Indonesia’s emerging-market classification.
There was a violent response. The IHSG plunged over the following two sessions, contributing to roughly US$80 billion in lost market value. Reuters described the episode as a rush for the exits, while Bank Indonesia recorded Rp12.40 trillion in net foreign selling of Indonesian equities between 26 and 29 January.
The rupiah also came under renewed pressure. Bloomberg Technoz explicitly linked the turbulence following MSCI’s decision to continuing pressure on the currency, although it expected the FX effect to be more limited than the equity-market shock because of Bank Indonesia’s intervention.
Prior to this, the currency was already weak. However, it it poses a more interesting question: Why should an equity index provider’s decision have any bearing on the exchange rate?
One possible answer comes from Xavier Gabaix and Matteo Maggiori’s theory of International Liquidity and Exchange Rate Dynamics. Their framework departs from the assumption that international financial markets can absorb capital flows frictionlessly. Instead, global financiers have limited capacity to take the opposite side of investors’ positions. Capital flows therefore alter their balance sheets, and financiers must be compensated for absorbing additional currency risk. Exchange rates adjust as part of that compensation.
Suppose foreign investors suddenly want fewer Indonesian equities. Selling those assets is not merely a movement in the IHSG. If investors also reduce or repatriate their rupiah exposure, the transaction creates additional demand for foreign currency. Someone must take the other side and hold the resulting rupiah risk.
If plenty of investors are willing to absorb that position, the exchange-rate adjustment may be small. But when risk-bearing capacity is limited, the rupiah may have to depreciate substantially before investors are willing to hold the exposure.
This makes the MSCI connection particularly curious. Gabaix and Maggiori themselves discuss evidence from Hau, Massa and Peress, who used changes in MSCI index weights to identify portfolio-flow shocks. Countries receiving greater MSCI-induced inflows tended to experience currency appreciation. Indonesia’s recent episode resembles the opposite experiment: reduced expected demand for Indonesian assets, foreign selling, and pressure on the currency.
The more important lesson may therefore be that exchange rates are not determined only by interest rates or trade flows. They also depend on who is willing to hold a country’s financial risk, and at what price.
This raises an uncomfortable implication.
Global investors do not base their capital allocation decisions only on inflation, growth or policy rates. Their portfolios are also shaped by benchmark inclusion, investability rules, classifications and institutional assessments. A decision made by an index provider can consequently generate mechanical portfolio reallocations even when the underlying productive capacity of the economy has barely changed.
This does not imply that fundamentals are no longer important nor that MSCI “controls” the rupiah. They continue to be crucial over longer time horizons. However, the architecture of international finance and the willingness of foreign investors to take on Indonesian risk may have a significant short-term impact on the value of the rupiah.
Perhaps that is the more pressing concern.