Diplomatic Tiff Affects Stocks in Hong Kong : Securities: A war of words between China and the colony’s governor over Hong Kong’s future makes trading volatile.

HONG KONG —  The escalating Sino-British war of words over Hong Kong’s 1997 reversion to Chinese sovereignty is giving stock market investors fits, even though Hong Kong’s economy remains fundamentally sound.

Share prices nose-dived for four consecutive days last week before rebounding nearly 6% on Friday. The blue chip Hang Seng index, which fell more than 1,000 points Monday through Thursday, soared 289.89 points on Friday to 5,268.10. Brokers in Hong Kong said Friday’s rise was unsustainable and that they expected the Hang Seng to resume its downward slip today.

Still, market players remain wary.

“I don’t think we’re out of the woods yet,” said John Mulcahy, director of research for Peregrine Brokerage Ltd. “I think the market is going to be very volatile in the short run, with swings of a couple hundred points here and there on a day-to-day basis.

“After a plunge in the market of those dimensions that we had seen earlier in the week, it’s natural that at some point there would be a rebound,” Mulcahy said.

Thursday’s collapse of 433.44 points was the biggest point loss for the Hang Seng since the 1989 Beijing massacre, when Chinese troops crushed the student democracy movement in the city’s Tian An Men Square.

The latest market slump was fueled by a series of Chinese statements last week. On Monday, China threatened to revoke contracts signed with the Hong Kong government that take effect after the British colony’s transfer date.

Then on Thursday, a China Foreign Ministry spokesman accused Britain of violating some terms of the 1984 Sino-British Joint Declaration on the return of the colony to Chinese sovereignty, giving the appearance that China might refuse to abide by the agreement.

Local analysts say they were heartened by Friday’s market rebound, which came despite Britain’s diplomatic counterattack against China in the struggle over Hong Kong Gov. Chris Patten’s sweeping constitutional reform package to advance democracy in the colony.

In an interview with the British Broadcasting Corp. radio in London on Thursday, British Foreign Secretary Douglas Hurd rebuked China for its continued threats in the battle over Patten’s plans for democratic reforms in Hong Kong.

Although politics are clouding Hong Kong’s economic outlook, the underlying economy appears in good health.

“In Hong Kong, company profits are growing by 25% to 30% a year, and economic growth is going to be around 5.5% this year,” Mulcahy said. “But still, momentum has been building up (in the Sino-British disagreement). . . . Given the fact that traditionally the stock market is a crucial barometer of political sentiment in Hong Kong, it would suggest that the mood has become anxious to say the least.”

Last month, neither Patten’s proposals nor the early stages of the Sino-British confrontation provoked upheavals in the market.

But as political tensions continue to overshadow life in the colony, many analysts predict that the toll will be felt in the market, with further declines expected.

“China is concerned over the long-term political structure in Hong Kong and fears the spread of democracy” into South China, said Edward Chan, research director for Standard Chartered Securities.

“On the other hand, I think Chris Patten is a very stubborn governor. He’s going to put forward the draft legislation to the Legislative Council next February, so I don’t see any possibility of concessions from either China or Mr. Patten.”

Although politics have gripped the market in the short term, analysts believe that the long-term picture may not be as gloomy, thanks to Hong Kong’s growing economic ties with Southern China.

“Ultimately, the reason for Hong Kong’s stock market strength in the past year and a half has been the realization that Hong Kong is making a heck of a lot of money from China, and that China is investing heavily into Hong Kong according to the rules,” said Robert Broadfoot, managing director of Political & Economic Risk Consultancy Ltd.

With an estimated $10 billion or more invested in Hong Kong, Chinese enterprises are suffering as much as local and international investors.

Analysts say it is essential to differentiate between politics and economics, stressing that there has been no fundamental change in the economies of Hong Kong and Southern China.

“The reactions all week have been purely of perceived problems or perhaps people thinking of the possibility that there will be a fundamental change” in the colony’s economy, said David Lavington, director of sales for Morgan Granfell Asia Securities (H. K.) Ltd. “But we’ve seen no indication of that coming true.”