The 31-year-old had been battling to recover from the injury in time for the tournament, which takes place in September and October in New Zealand, with Scotland opening their campaign on September 10 against Romania.
Although the Stade Francais player is hopeful of returning to fitness ahead of that date, an early decision has been taken to withdraw him from contention.
Scotland coach Andy Robinson revealed on the Scottish Rugby Union's website: "After talking this through with Hugo, we've taken the decision to stand him down from our Rugby World Cup squad by mutual consent.
"Hugo has been working hard to recover from a knee injury but has not been able to take a full part in our training camp and while he may be fit to resume playing in mid-to-late August, both Hugo and I have decided that he will not be part of our World Cup plans.
"Hugo has been very diligent in his rehabilitation programme and I'm sure he will be determined to perform for Scotland again in the future."
Southwell, who played five games in the 2007 tournament in France, will not be replaced in Scotland's squad, leaving Robinson with 38 players to work with. The coach will announce his final 30-man party on Monday, August 22.
Gilbert has released a new line of rugby cleats. The Gilbert Virtuo 8S is part of the exciting new product. Check it out.
The Barbarians are one of the top invitational rugby sides with a long history and classic rugby jersey.
The Nike Tiempo is a solid rugby cleat and one of few styles still made from full-grain natural leather.
The Lions get ready for their matches with this green training jersey. It's what the players wear. Get in the Gear!
A cool looking all black rugby cleat with the high performance adidas is known for. Get in the Gear!
Wear the crest of the British and Irish Lions on your t-shirt. A great look for the summer.
The Lions are ready to get their Australia tour underway. They arrive in Perth on Monday.
The New Zealand All Blacks training jersey for 2013/14. Get in the Gear!
The USA Rugby Pro Alternate rugby jersey is perfect for any fan of the Eagles. Get yours to wear during the summer Test matches.
The NEW All Blacks 2013/14 jersey has arrived at World Rugby Shop. Dare to wear the colors of the All Blacks.