Gwangju Mayor Kang Un-tae has been accused of forging the signatures of former prime minister Kim Hwang-sik and former culture minister Choe Kwang-sik in a bid document that guaranteed financial support from the government for the event.
Despite the allegations, world governing body FINA awarded Gwangju the 2019 hosting rights on Friday.
Yonhap news agency quoted a government official, who requested anonymity, as saying that Seoul had decided to withdraw support in the wake of the alleged forgery.
"We define the Gwangju city government's forgery of a document guaranteeing the central government's financial support as a case in which a municipal government deceived a state organisation, disrupting the discipline of the state," the official said.
"The authority decided not to execute the budget pledged for the event as punishment for the forgery."
Any South Korean city seeking to host an international sporting event that requires at least 1 billion won ($895,000) in government support must gain separate permission from the country's Olympic committee and central government.
Despite the report, Kang was confident the government would fund the host city and said he had ample time to sort out differences with the authorities.
"I will clear up misunderstandings with the government," Kang told reporters at Gwangju airport after returning from Spain. "The event is not taking place next year, but in 2019. I believe the government will fund (the city).
"Winning the bid to host the event was a bumpy ride, but it was successful thanks to Gwangju citizens.
"It's glory not only for Gwangju and its citizens, but for all of Korea."
Barcelona is hosting the ongoing world championships while Kazan, Russia will host the 2015 edition, followed by Guadalajara, Mexico in 2017. Hungary's Budapest was awarded the right to host the 2021 championships.
- Politics & Government