YAU Lee Holdings, a victim of the downturn in Hong Kong's construction industry, is trying to reverse the plight by diversifying and by recovering a substantial loss on a Government contract. The construction firm recently reported a 61 per cent profit drop to $32.3 million in the year to March 31. A fall in public sector contracts and additional building costs for the Cheung Sha Wan wholesale market were blamed. Yau Lee chairman Wong Ip-kuen said the company was negotiating with the Government to recover the extra costs on the $500 million contract. Because the contract was part of the Airport Core Programme, mediation rather than arbitration would resolve the problem, he said. Mr Wong declined to reveal the sum involved, but expected the money spent could be repaid within the fiscal year. ''It was all due to some construction problems under the wholesale market site which Yau Lee failed to foresee,'' he said. However, because the company adopted a prudent accounting policy, the recovery of the costs was not taken into account in the previous fiscal year, he said. Mr Wong stressed that Yau Lee would continue to move into other construction-related businesses in a bid to strengthen its income base. For example, timber products, ready-mix concrete and quarry development operations would add strong support to the company's property projects in China, he said. Mr Wong believed the diversification efforts would pay off in the next one or two years. He expected the construction industry would bottom out this year as the Government was prepared to release more capital works projects for tender. Capital under-spending by the Government during 1992 resulted in the delay of many public works projects which constitute the mainstream of Yau Lee's construction portfolio.