President Joko Widodo said the new capital will be in the East Kalimantan province on the island of Borneo, known for its rainforests and orangutans.
The move from Jakarta – which is sinking and has major issues with overcrowding and pollution – has been years in the making.
The new capital city has not been named. Construction will take up to a decade, the president said, and will cost £26.5 billion.
Mr Widodo said on Monday: “We couldn't continue to allow the burden on Jakarta and Java island to increase in terms of population density.
“Economic disparities between Java and elsewhere would also increase.”
He said the pressure on Jakarta and Java island has become too heavy as the centre of government, finance, business, trade and services – as well as the location of the country's largest airport and seaport.
Jakarta has a population of 10 million people, or 30 million including those in its greater metropolitan area.
It is prone to earthquakes and flooding and is rapidly sinking due to uncontrolled extraction of ground water, which is highly contaminated – as are the city’s rivers.
Mineral-rich East Kalimantan was once almost completely covered by rainforests, but illegal logging has removed many of its original growth. It is currently home to only 3.5 million people.
Mr Widodo said his government is drafting a law on the new capital which will need to be approved by Parliament.
Additional reporting by Associated Press.
