The decision to remove Indonesia as host of the May 20-June 11 tournament was taken after its football federation said it had cancelled the draw after the governor of the largely Hindu island of Bali refused to host Israel's team.
"FIFA has decided, due to the current circumstances, to remove Indonesia as the host of the FIFA U-20 World Cup 2023," a FIFA statement said.
"A new host will be announced as soon as possible, with the dates of the tournament currently remaining unchanged. Potential sanctions against the PSSI may also be decided at a later stage."
FIFA added that the decision had been taken following a meeting between the world soccer governing body's President Gianni Infantino and PSSI Chairman Erick Thohir.
PSSI officials did not immediately respond to Reuters' requests for comment.
Earlier this month, protesters marched in the capital Jakarta waving Indonesian and Palestinian flags and demanding Israel not be allowed to participate.
Indonesia's population is predominantly Muslim. Most Indonesian Muslims practice a moderate version of Islam, but there has been a rise in religious conservatism in recent years that has crept into politics.
Earlier this week, the PSSI said losing hosting rights would harm Indonesian football teams' chances of taking part in other FIFA tournaments, while the economic losses would amount to "trillions of rupiah".
On Wednesday, FIFA said that it was committed to aiding the PSSI following a deadly stampede last year that led to the deaths of 135 spectators at a stadium in East Java in October.
"Members of the FIFA team will continue to be present in Indonesia in the coming months and will provide the required assistance to the PSSI, under the leadership of President Thohir," FIFA said in the statement.
"A new meeting between the FIFA President and the PSSI President for further discussions will be scheduled shortly."
As host, Indonesia automatically qualified for the Under-20 World Cup, but it has not played in the tournament since 1979.