FTSE Russell likely to add South Korea to watch list for debt index inclusion -vice minister

© Reuters. FILE PHOTO: A man walks in a park at a business district in Seoul, South Korea, March 23, 2016. Picture taken on March 23, 2016. REUTERS/Kim Hong-Ji

By Cynthia Kim, Jihoon Lee and Seunggyu Lim

SEOUL (Reuters) - FTSE Russell is likely to add South Korea to a watch list in coming weeks for inclusion in its World Government Bond Index, the country's vice finance minister said on Wednesday, heralding a move that could bring huge inflows of foreign funds.

"We are closely working with FTSE Russell... and we've been receiving positive signs from them," Choi Sang-dae, second vice finance minister in charge of budget and treasury bond markets, said in an interview with Reuters.

"We see a high chance of joining the watch list this September," said Choi, describing the progress South Korea is making toward inclusion in one of FTSE Russell's flagship indexes.

The WGBI comprises of sovereign debt from more than 20 countries as global funds tracking the index is estimated at around $2.5 trillion, with Japan having the biggest weighting in Asia.

The index provider reviews its watch list for possible inclusion every March and September and announces additions every September.

Inclusion in the index could potentially draw inflows of billions of dollars into Korean bonds, and help lower borrowing costs.

Partly to improve chances of entry to the index, the finance ministry has laid out a path to fiscal repair in budget proposals for next year.

Choi said the government aimed to keep its debt at the equivalent of 52% of gross domestic product by 2026, just slightly up from the 50% estimated for Asia's fourth largest economy this year.

On Tuesday, the finance ministry said it would cut annual government spending in 2023 for the first time in more than a decade, as it strives to cut back on pandemic-era stimulus and help the central bank temper inflationary pressures.

Choi said subsidies related to education and hydrogen cars would be gradually reduced over the next few years, he said.

Goldman Sachs Group Inc (NYSE:GS). reckoned South Korea could be allotted a 2.34% weighting within the index, and its addition could trigger inflows of $60 billion to South Korean bonds as a one-off adjustment.

The finance ministry is seeking to remove a tax on foreign investment in its bond market to improve market accessibility to overseas investors and the bill is currently being reviewed by the National Assembly for final approval.

In addition to tax burden, foreigners' limited access to South Korea's foreign exchange market has been often cited as a major obstacle to be included in the index, but Choi said there had not been any concern raised over it during talks with the index provider so far.

Choi also said there was "no chance" that South Korea would put plans to join the index back on ice even if the won were to gain sharply against the dollar.

South Korea's transition toward fiscal tightening, comes as many other governments persist with expansionary fiscal policies even as their central banks have raised interest rates to tackle soaring inflation.

"Economic recession has not yet materialized, while high inflation still persists, and there may be side-effects to excessively expansionary fiscal policy in these conditions. Expanding fiscal policy is not always best answer to support economic growth," Choi said.

Subsidies related to education and hydrogen cars would be gradually reduced over the next few years, he said, adding that there would be a thorough spending review for the years to come.

And subsidies for primary school to middle school students could be cut amid the falling numbers of school-age children.

"Fiscal policies need to focus on deploying targeted approach to help the underprivileged who suffer more in times of economic downturns."