BRITAIN ultimately will back down in the political row with China, says Nomura Research Institute Hongkong. However, the Sino-British impasse over the extent of political reform in Hongkong is likely to drag on into July, threatening business confidence, Nomura says. Meanwhile, the resulting erosion in confidence could inflict lasting damage on the territory's economy and its fundamentals, in particular the residential property market. ''The fundamentals have not as yet been materially impacted and it is likely that the stock market would bounce back strongly,'' the Japanese brokerage firm's research arm says in a report released yesterday. ''However, if . . . this issue drags on for another six months or more, then the outlook begins to look a little less rosy. ''Confidence will gradually erode, with the first concrete indications likely to come in the form of weak retail figures this Christmas.'' However, the brokerage maintains a positive long-term view of the market. While the substance of the proposed reforms is of little consequence in practical terms, it has become ''abundantly clear'' that China will not compromise over what it perceives to be matters of sovereignty. The dispute probably will be resolved in the Legislative Council, which is likely to water down Governor Chris Patten's October proposals for electoral reform until they are acceptable to China. Britain is predisposed to compromise, as China has already agreed to gradually increase the number of directly elected seats to about the levels proposed by Mr Patten by 2004. Meanwhile the Hang Seng Index could, on a technical basis, drop to the 4,200-4,300 range, but Nomura sees significantly more upside potential than downside risk. Given that the political clouds will remain for some time to come, Nomura is recommending investors gradually buy into oversold blue-chips and high-quality industrials which will be more insulated from political events. The brokerage recommends solid weightings in China Light and Power, Sun Hung Kai Properties and Swire Pacific. Hang Seng Bank merits a higher weighting than parent HSBC Holdings among the three financial stocks recommended, the third being newcomer National Mutual on the basis of its strong earnings growth and predictability. Hongkong Electric, Henderson Land, Hongkong Land, Wharf Holdings and Jardine Matheson each merit a moderate weighting in this year's model portfolio, which dismisses the hotels, food-and-beverage and construction sectors as laggards. Selected manufacturing stocks are viewed as worthy of a light weighting, including Yue Yuen, MC Packaging, Johnson Electric, Varitronix and Chen Hsong.