The KOSPI, won-dollar exchange rate and Kosdaq index are displayed on a digital board at Hana Bank's dealing room in Seoul, Thursday. Yonhap

The full resumption of short selling in Korea on March 31 is expected to serve as a stepping stone for the return of foreign investors to the domestic stock market, analysts said Sunday.

They said the influx of foreign capital following the resumption will help reinvigorate the local bourse, which has been struggling with weakened resilience after seven months of net selling by foreign investors in the main KOSPI market.

Korea imposed a ban on short selling in November 2023 after financial authorities discovered a series of naked short selling violations by several global investment banks. The ban is set to be lifted next Monday, with the authorities emphasizing regulatory enhancements and stricter oversight.

According to the Korea Exchange data, domestic stocks held by foreign investors were valued at 741 trillion won ($506 billion) as of Friday, accounting for 29.2 percent of the total market cap.

The foreign ownership ratio has remained in the 20 percent range for six consecutive months after falling below 30 percent last September, due largely to foreign investors' continued net selling from August.

Securities analysts expect the resumption of short selling will facilitate foreign capital inflows as the ban has been widely cited as a major obstacle to attracting foreign investment.

"Just before the short selling ban, more than 60 percent of short selling transactions were made by foreign investors," Shinyoung Securities analyst Lee Sang-yeon said. "Given that foreign investors typically employ long-short hedging strategies, the resumption of short selling is expected to boost market liquidity."

Bae Cheol-gyo, an analyst at NH Investment & Securities, also said that the resumption could encourage greater participation by foreign investors. "With foreign capital inflows currently at a low point, there is significant room for expansion," he said.

Another factor raising expectations for the return of foreign investors is the increased likelihood of Korea's inclusion in the developed market index of Morgan Stanley Capital International (MSCI).

The MSCI index is a key global benchmark for measuring equity market performance. It classifies world markets into developed, emerging and frontier markets, based on criteria such as economic scale and market openness.

MSCI announces its market classifications every June. In its latest review last year, it maintained Korea's classification as an emerging market, citing the short selling ban as a key factor limiting market accessibility.

"The short selling resumption is not just a step toward capital market advancement, but also the first step toward Korea's inclusion in the developed market index of MSCI," DS Investment & Securities analyst Shin Min-sub said.

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However, analysts stressed that, beyond the short selling resumption, broader improvements in the domestic investment environment are crucial for sustaining foreign capital inflows. They pointed to the need for a stable won-dollar exchange rate and the resolution of political risks as key factors.

Since President Yoon Suk Yeol's Dec. 3 martial law declaration, economic instability has intensified and the exchange rate has risen. The Constitutional Court is set to deliver a ruling on Yoon's impeachment trial soon.

Daishin Securities analyst Lee Kyung-min noted that if domestic political risks subside, the won-dollar exchange rate could fall to the mid-1,300 won range in the first half of the year.

"If the Korean won is expected to appreciate, foreign buying pressure will strengthen. In particular, if the won's appreciation against the dollar accelerates, net foreign buying is likely to increase further," Lee said.