This Aug 28, 2019 photo shows a view of Hong Kong. (PAUL YEUNG / BLOOMBERG)

Hong Kong’s stock rally is so dependent on mainland capital that the mere suggestion the record inflows will slow has the potential to stir panic in the city’s US$7.1 trillion market.

Such was the case on Tuesday, when the People’s Bank of China (PBOC) withdrew incremental liquidity and an adviser warned obliquely of asset bubbles. The result was the biggest drop in eight months for the Hang Seng Index. State media was quick to calm nerves, with the Securities Times urging investors in a front-page editorial to avoid reading too much into the central bank’s money-market operations.

The benchmark stabilized on Wednesday, losing just 0.3 percent, even though the PBOC withdrew a greater amount of funds than the prior day. On Thursday, the benchmark fell as much as 1.7 percent in morning trade as the PBOC withdrew short-term liquidity at the fastest pace in three months.

As one of Asia’s largest and most open equity markets, Hong Kong is particularly sensitive to shifts in global liquidity. Driving its almost US$600 billion rally this year has been plentiful cash on the Chinese mainland, where strict capital controls and ultra-low interest rates have left residents with few investment options.

ALSO READ: Mainland cash boosting HK stocks sales after record year

Mainland-based funds bought a net US$38 billion of Hong Kong shares this month through Thursday morning - or 44 percent of last year’s total

Foundation Asset Management (HK) Ltd.’s Michael Liang says the PBOC - along with many of the world’s major central banks - will continue flooding markets with cheap money.

“Liquidity is going to be with us for a long time to come,” said Liang, who as chief investment officer at Foundation Asset holds shares of Tencent Holdings Ltd. and Meituan. “We’ll continue having central bank support and fiscal policy support as long as COVID is with us.”

China Securities Journal reported on Thursday that there was no need to worry about continued liquidity tightening as the central bank is expected to offer necessary support to address any shortage before the Lunar New Year holiday. The central bank’s caution may be related to the recent rapid rise in some asset prices, it added.

The liquidity withdrawals had an outsized impact on sentiment because the PBOC typically pumps funds into the financial system before the Lunar New Year, which falls in mid-February this year. Demand for cash increases during the weeklong holiday as residents load up on gifts for relatives.

This year, authorities are more focused on preventing stimulus measures from inflating asset prices, especially as the economy recovers from the pandemic. The central bank will continue to support growth while curbing risks after debt surged to 280 percent of output, Governor Yi Gang said this week.

READ MORE: PBOC governor aims to stabilize debt ratio, curb risks

Dozens of mutual funds and exchange-traded products are opening in the mainland to unprecedented demand. Many of them are now targeting Hong Kong’s far cheaper equity market. A pipeline of high-profile Chinese listings in the city, such as Kuaishou Technology, is also amping up interest among mainland investors.

Mainland-based funds bought a net US$38 billion of Hong Kong shares this month through Thursday morning - or 44 percent of last year’s total - with inflows accelerating after the CSI 300 Index of stocks in Shanghai and Shenzhen rose to a 13-year high.

READ MORE: Record mainland inflows push Hang Seng past 30,000 points

A key test will come when southbound links close for seven trading days from Feb 9 due to the Lunar New Year holidays.

The cash looks set to keep coming after the break, which is good news for jumpy Hong Kong stock bulls. Strategists at Goldman Sachs Group Inc. predict southbound net inflows will reach US$95 billion in 2021, almost double their previous forecast. Citigroup Inc. analysts have outlined a scenario in which this year’s figure could approach US$400 billion. Even on Tuesday, when the Hang Seng Index fell 2.6 percent, mainland investors bought a net US$1.8 billion.

“The rally will continue,” said Sandy Mehta, chief investment officer for Value Investment Principals. “Cyclical names including banks and industrial companies should have more upside.”