By Cynthia Kim and Yena Park
SEOUL (Reuters) - The surprise inclusion of South Korean sovereign bonds in the FTSE Russell's benchmark bond index is expected to give the won currency a boost on Thursday and attract billions of dollars of inflows over the next few years.
South Korea's government has projected the inclusion to the World Government Bond Index could draw as much as 80 trillion won ($59.7 billion) into its $2.2 trillion bond market, a welcome source of funds for the world's fastest-aging country as welfare costs look set to surge.
The inflows are also expected to provide a shot in the arm for the won, which is down 4% against the dollar so far this year and a slumping stock market, analysts say.
Korea's financial markets are closed on Wednesday for a public holiday so are set to react on Thursday.
"For Korea, the inclusion means steady and stable source of money inflows and signals that the 'Korea discount' could be eased," said Kim Han-soo, an analyst at the Korea Capital Market Institute.
The Korea discount refers to a tendency for South Korean companies to have weaker valuations than global peers due to red tape, low dividend payouts and the dominance of opaque conglomerates known as chaebols.
"Korea's unique, restricted FX market has always been a problem, but the accession means global investors now approve of the system," said Kim, referring to South Korea's efforts to increase participation by foreign banks in currency markets.
The FTSE Russell decision follows President Yoon Suk Yeol's broader reforms to eliminate the Korea discount and boost inflows by getting the country into top-shelf indexes such as the WGBI and MSCI's developed market benchmarks.
Among the reforms South Korea has adopted to boost foreign access to financial markets are the launch of an omnibus account for Korean treasury bonds with securities settlement house Euroclear, allowing of overdrafts in the won through the International Central Securities Depository, and extended onshore trading hours for the won.
Despite these efforts, the won has lost ground this year and while the KOSPI has fallen 2.3%, underperforming the S&P 500's and Nikkei's strong gains.
Seoul's reform efforts were also clouded by the government's reimposition of a full ban on stock short-selling last year, which prompted index provider MSCI Inc. in June to retain South Korea's classification as an emerging market.
Goldman Sachs and Morgan Stanley recently said Korea's addition to the FTSE Russell index may be delayed to next year due to a lack of meaningful global bond settlement volumes using Euroclear.
"It's a surprise decision, and we are temporarily seeing some dollar selling in offshore USD/KRW. There is going to be some more demand for the won-based assets," an FX dealer said, asking not to be named due to internal policies.
Asked to comment on the index provider's decision, director Kwak Sang-hyun at South Korea's finance ministry said Seoul's pitch to FTSE Russell was made on expectations Euroclear settlements would pick up once Korea was added to the index.
"Inclusion will help new investors to settle bonds via Euroclear. The decision is a vote of confidence from global investors, and the inflows will allow Korea to have more fiscal policy room even if government debt increases," said Kwak.
South Korean government bonds are projected to comprise 2.22% of the debt gauge and will be added to the index starting November 2025, which will be phased in over a one-year period on a quarterly basis.
($1 = 1,340.7000 won)
(Additional reporting by Jihoon Lee; Editing by Ed Davies and Sam Holmes)