FOR 50 years, from Betsy to Boeing, Cathay Pacific has dominated the skies over Hong Kong. But with less than 26 months before the territory's sovereignty reverts to China, the airline has hit turbulence. It is not the row with Australian carrier Qantas nor the push by Taiwan's China Airlines to gain a foothold in the Hong Kong market that has troubled investors in the company. What made the analysts really sit up last week, and prompted Cathay chairman Peter Sutch to send a calming message to staff, was news of a potential rival airline setting up in Hong Kong. The China National Aviation Corp (CNAC), a wholly owned subsidiary of the mainland's aviation authority, has applied for an Air Operator's Certificate (AOC), one of the first steps towards creating a Hong Kong-based airline. The reaction in the markets was swift. By Thursday Cathay's share price had fallen 6.2 per cent to $10.60 before recovering to $10.85 by the week's end. Parent company Swire Pacific had fallen 7.3 per cent to $50.50 by Wednesday before climbing to $51.75 by the end of trading on Friday. Cathay's management cleared the front page of their in-house newspaper The Weekly to declare the challenge could be contrary to the Joint Declaration, while CNAC's general manager Hu Yilin was quoted as saying that as Hong Kong was to be a part of China, it was 'only natural' it wanted to set up its own airline here. This goes to the heart of the issue - is CNAC a Hong Kong carrier? The answer, according to Cathay, is definitely not. 'It raises very real questions,' said Mr Sutch. Allowing a Chinese-controlled company to call itself a Hong Kong entity runs contrary to the Aviation Annex in the Joint Declaration, which requires a Hong Kong carrier to be genuinely based in the territory, Mr Sutch told Cathay's newspaper last week. Under the wording of the Joint Declaration a Hong Kong carrier must be incorporated in the territory and have its principal business in Hong Kong. CNAC has been incorporated in Hong Kong for many years but remains controlled by Beijing. Analysts remain divided on whether CNAC qualifies as a Hong Kong carrier. 'If Virgin set up a Hong Kong offshoot here would they be considered a Hong Kong carrier?' asked one industry source. Others believe it would be difficult to deny CNAC its claim as an airline of the territory. The question to a large extent boils down to political will. CNAC's application is the first of several steps to gain the status of a Hong Kong carrier. The application for an AOC will take about six months to be approved, but the CNAC will still have to apply for access to routes being used by Cathay and the other Hong Kong-based carriers - Cathay associates Dragonair and Air Hong Kong. The Government currently has a one-route, one-airline policy. According to a Hong Kong Government source, if it was in the public interest and traffic volume warranted more carriers, the policy could be reviewed on a case-by-case basis. 'But the general view is we should not take existing capacity from operators and give it to a new operator without very good reason,' he added. Cathay had made heavy investments to develop some of its routes. 'If there was suddenly a new entrant and routes were taken away to give to the new boy it would seem a little unfair,' he said. Wong Kam-ming, aviation analyst with S G Warburg, said: 'It is probably not too much of a problem to get an AOC on technical ability. The real test for someone like CNAC is whether they can get the routes. 'We have already seen cases years ago when Dragonair tried, and failed, to get some of the profitable routes. There is no doubt that CNAC would try and muscle in on some of Cathay's routes and it will come down to a policy decision by the Government.' The CNAC move also appears to signal change of strategy. Previously the CAAC, China's ruling regulatory body, had looked at Guangzhou as a base for China Southern, Shanghai as a base for China Eastern and Beijing as a base for Air China. 'It was quite a shock to see CNAC coming into Hong Kong through the back door,' said one analyst. CNAC's plans for the Hong Kong market have also thrown up another theory among aviation analysts in the territory: even if Cathay's position in the skies remains unchallenged, ownership of the carrier could be under question. 'CNAC will take a long time to establish a network and a market reputation so any threat to Cathay is not imminent,' said Ng Ki-yi, an analyst at Standard Chartered Securities. 'But when the Chek Lap Kok airport is completed in 1998, and Hong Kong has returned to Chinese sovereignty - then, given CNAC's powerful background, it's very likely that it will be a major influence on the market,' said Terence Chan, regional aviation analyst at Kleinwort Benson. 'It is possible that CNAC will use some administrative or political means to intervene in the Hong Kong market. It could, for example, take all the prime slots leaving Cathay with the early morning and late night schedulings. The underlying threat to Cathay's dominance could force it to look at a deal with the Chinese.' If Swire was willing to reduce its stake in Cathay, and if CNAC took a bigger slice of the airline, the situation might change, he added. According to one analyst, Swire could be prepared to 'sacrifice the diminishing returns on the airline monopoly in exchange for future investment opportunities on the mainland'. Currently, Swire holds a 52 per cent stake in Cathay, 12.5 per cent is owned by CITIC Pacific and five per cent by CNAC. While it is natural for Beijing to prefer Chinese ownership of Cathay, Mr Chan said it was too early to say if CNAC was being serious about its airline expansion in the territory. 'CNAC is in a good position of either taking an active role in participating in the local industry or being a passive buyer for Cathay,' said another analyst.