Indonesia’s Rupiah Slide: Lessons from Three Generations of Currency Crises

Muhammad Syarkawi Rauf (Lecturer at FEB Unhas and Chairman of the ASEAN Competition Institute – ACI)

Currency turmoil in the post–Bretton Woods era has unfolded in three distinct “generations” of exchange-rate crises. The first emerged in the 1980s, centered in Latin America—Chile, Brazil, Mexico, and Argentina—where governments maintained fixed exchange-rate regimes pegged to the US dollar.

The first-generation crisis began with large inflows of hot money into Latin American economies. That wave reversed abruptly as short-term capital rushed out, triggered by US Federal Reserve rate hikes under then-chairman Paul Volcker, introduced in response to exceptionally high US inflation in 1979.

At the time, the sharp rise in US interest rates coincided with an extreme decline in global commodity prices. The combination left Latin American economies unable to service debt that had ballooned from $125$ billion to $800$ billion US dollars by the end of 1979.

The second-generation exchange-rate crisis unfolded in 1994, with Mexico at its core. It began with massive capital inflows after Mexico joined the North American Free Trade Area (NAFTA). Privatization of state-owned enterprises improved efficiency and helped attract foreign investors on a large scale.

However, those moves were accompanied by persistent doubts about the Mexican government’s credibility in defending its fixed exchange-rate commitment, particularly amid a large current-account deficit. The peso ultimately suffered an extreme depreciation of up to 50 percent as hot money exited in force.

This pressure compelled the Mexican government to devalue its currency. Investor confidence in the peso evaporated, leading Mexico to seek assistance from the International Monetary Fund (IMF) in early 1995.

The third-generation crisis struck Asian economies in 1997, centered on Thailand, Indonesia, the Philippines, Malaysia, and South Korea. It erupted at a time when many Asian countries were posting strong growth, low inflation, fiscal deficits below 3.0 percent of gross domestic product (GDP), and current-account surpluses.

As in earlier episodes, the third-generation crisis was preceded by sizable hot-money inflows, drawn by rapid growth and strong returns. The next phase brought sudden outflows that undermined fixed exchange-rate regimes.

The 1997 Asian crisis differed from the first and second generations in Latin America in one critical way: it spread far more broadly, rippling across countries and markets. It was marked by a contagion effect—an unfolding domino sequence that began with Thailand’s baht and then triggered a confidence shock and exchange-rate stress across the region.

Economist Dani Rodrik (2019) of Harvard’s John F. Kennedy School of Government argued that the Asian crisis was fueled by “hyper-globalisation” of investment flows into the region. In that environment, stock prices across Asia, including in Indonesia, rose by as much as 500 percent.

Against that backdrop, a key question emerges: Could today’s rupiah depreciation against the US dollar develop into a currency crisis resembling the first, second, or third generation? And what risk-mitigation steps can the government and Bank Indonesia (BI) take?

For context, during the 1997 Asian financial crisis, the rupiah’s weakening was swift and severe, reaching 594 percent within a year—from Rp. 2,441 per US dollar in June 1997 to Rp. 17,000 per US dollar in June 1998.

Today’s move looks far more contained. The rupiah has weakened by 5.30 percent, from Rp. 16,120 per US dollar on Aug. 14, 2025, to Rp. 16,975 per US dollar on Jan. 21, 2025. At the same time, the probability of a 1997-style contagion effect appears low. The 1997 crisis began with a speculative attack that drove the Thai baht down by 20 percent in a single day—an abrupt shock that is not currently mirrored in the region.

A fourth-generation crisis on the scale of earlier episodes therefore appears unlikely. Still, the government and BI should prepare mitigation measures to address the risk of capital-flow reversals—particularly in the sovereign bond market—reflected in the decline of foreign ownership from 41 percent in 2018 to 13 percent in 2025.

That shift is also visible in Indonesia’s net capital flows, which turned negative from the first through the third quarters of 2025: an outflow of $387$ million US dollars in Q1 2025, $3.52$ billion US dollars in Q2 2025, and $8.07$ billion US dollars in Q3 2025.

In the short term, there are limits to what policymakers can do. First, Indonesia should reduce its country risk premium through policy communication that is more technocratic and rational than populist or rhetorical, aligning with an economic principle of prudence.

Second, the government must reassure markets through prudent fiscal and monetary policy. It should avoid any perception of dominance or intervention in BI’s role in designing national macroeconomic policy.

Third, policymakers should communicate transparently with markets on fiscal conditions—particularly the fiscal deficit-to-GDP ratio, which has reached 2.92 percent, close to the 3.0 percent threshold often viewed as a safe limit, as well as the debt service ratio (DSR), which is above the commonly cited safety level at 42.3 percent.

Fourth, BI should avoid rushing to cut the policy rate, to preserve Indonesia’s real interest-rate differential with the United States while country risk premiums remain elevated. In parallel, BI can conduct measured foreign-exchange intervention to conserve reserves.

Fifth, drawing on the “impossible trinity” or policy trilemma framework, BI could prioritize exchange-rate stability and central bank independence by sacrificing full capital mobility. In practical terms, selective and targeted capital-flow measures could be considered as a short-term policy option.

Indonesianpost.com