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HK stocks seen volatile after Taiwan polls.

HONG KONG: Hong Kong stocks are expected to drop on Monday after the pro-independence DPP party won weekend presidential elections in Taiwan but would likely bounce back quickly due to strong fundamentals.

"It will press down the stock market, but I don't expect the impact to be very big, perhaps a few hundred points to the 16,500 level," said Ricky Tam of Delta Asia Securities.

Hong Kong's blue chip Hang Seng Index .HSI was shaken for much of last week by China's sabre-rattling to head off a DPP win, but on Friday the market took its cue from a record setting rally by the Dow Jones Industrial average .

The Hang Seng surged 723.99 points, 4.43 percent, to close at 17,082.99, recouping nearly half of its 1,472-point drop in the first four trading days. It was down 4.2 percent on the week.

Attention this week will be focused on any renewed tension with Beijing created by the victory of Taiwan President-elect Chen Shui-bian and his pro-independence Democratic Progressive Party (DPP).

Several analysts said the main question was whether Beijing backed away from earlier threats to retaliate against a pro-independence leader in Taiwan.

"Overall sentiment will be determined by China and Taiwan," said Howard Gorges, director of South China Brokerage. "It will be a bit of follow the leader. There will be caution at the start but if there's not much selling, we could see a turnaround.

Analysts saw some support but little real upside potential in changes to Morgan Stanley Capital International's (MSCI) China Free Index, which many fund managers use to allocate assets and measure performance.

MSCI added 15 China-linked Red Chips to the index in a wider re-evaluation than the market expected. Twenty-two companies were removed.

"The main changes are that the so-called Red Chips will be included in our definition of the China Free Universe," said John Fildes, vice president of Morgan Stanley Asia Ltd. "The market capitalisation of the MSCI China Free Index will go from US$3.9 billion to US$81 billion."

The Red Chips are companies which are incorporated and listed in Hong Kong but have most of their business in China and whose major shareholders are organisations owned by the state.

Investors were also cautious ahead of the U.S. Federal Open Market Committee monetary policy meeting on Tuesday. Many economists believe the Fed will push up its key interest rates by 25 basis points following the regular gathering.

Such a move would likely push up Hong Kong's interest rates at the weekly meeting of the Hong Kong Association of Banks on Friday.

"Hong Kong stocks are going to be volatile next week because of the Taiwan election, the U.S. Fed meeting on Tuesday, Cheung Kong and Hutchison earnings and the MSCI announcement," Stephen Li, Hong Kong strategist for Jardine Fleming Securities, said.-Reuters