SEOUL, Nov 14 (Reuters) - South Korean President Yoon Suk Yeol said on Tuesday a ban on short selling of shares would stay, as the practice becomes a hot political issue and defying warnings the move would make the $1.8 trillion equities market less transparent.

Yoon, whose ruling party faces legislative elections in April, said the short-selling ban announced on Nov. 5 would remain until "fundamental improvements" are made addressing the negative impact such selling had on retail investors.

"Neglecting the problem of illegal short selling would not only worsen unfair price formation issues, which can cause great losses to individual investors, but it also could hurt stock market credibility and cause investor withdrawal," Yoon said at a policy meeting in Seoul.

Retail investors welcomed the ban, with some posting "Thank You" notes online. They argue the practice of selling borrowed shares has only worsened price swings by allowing big players to bet on market declines.

However, analysts say the ban has made the market less attractive, denying investors options to hedge their risks and reducing liquidity and price recovery.

"The regulator is heading in the right direction with strong will, which is the right decision for the development of Korea's financial market," said Park Soon-hyuk, a 52-year-old proponent of the country's battery shares better known as Mr. Battery.

He sent a wreath to the Financial Supervisory Service last week to thank authorities for the decision.

"If the ban is permanent, the government should earn a free-pass on whatever criticism it faces in the future - they deserve it," said Sean Lee, a 38-year old office worker and shareholder of POSCO Future M, a Korean battery materials maker.

POSCO Future shares surged 30% a day after the ban was announced.

Retail investors have become a key voting bloc in recent years, with retail stock trading accounts doubling since 2017 to about 14 million and about one in every five Koreans holding an account.

More than 50,000 South Koreans petitioned for a temporary short-selling ban in recent months.

INTERNATIONAL REPUTATION

Analysts warn the move hurts fresh investment and discourages foreign investment at a time when Asia's fourth largest economy is seeking to win developed-market status from global index provider MSCI.

"South Korea wants to be upgraded to developed markets status with MSCI and this is not going to help," said Trinh Nguyen, senior economist for emerging Asia at Natixis.

"So it basically saves itself in the short term, but then you're not going to get these flows that you want, or the inclusion, and so on. So I guess this is to appeal to retail investors, but institutional investors don't like it."

The ban also contrasts with the government's recent steps to improve access for foreign investors.

Seoul has promised to open up the onshore Korean won market to foreign banks by extending market hours until 2 a.m. from 3:30 p.m. local time current, starting the second half of 2024.

Global stock index provider MSCI said in June it would consider promoting South Korea to its developed market index only after the measures to open market access were implemented.

In September 2022, South Korea made its way into FTSE Russell's watch-list for inclusion in the World Government Bond Index, which usually takes two years.

"The Yoon administration and the right-wing ruling People Power Party have recently released a series of economic policies, which could potentially increase the Yoon administration's popularity while raising economic policy uncertainty," Kim Jin-wook, an economist at Citi, said in a note.

Kim said the policies, including the short-sale ban and a reported review on the ceiling for large shareholders subject to the capital gains tax, could lead to inconsistent economic policies.

"Various academic research related to short-selling restrictions in developed markets suggests that such moves don’t necessarily help stock price direction or volatility, worsen liquidity and cost of trading," Rajiv Batra and two other analysts at J.P. Morgan wrote in a report.

(Additional reporting by Rae Wee in Singapore. Editing by Sam Holmes)