Addressing the anniversary, Chinese President Hu Jintao praised Hong Kong's experiences in the experimental "one country, two systems" structure, for giving a high priority to promoting economic development and improving the well being of its people and for upholding social order.

President Hu also witnessed the inauguration of HKSAR's third-term government. Chief Executive Donald Tsang and members of his cabinet were sworn in at the ceremony.

In his speech, Mr Tsang repeated his pledge to create a more democratic system in Hong Kong.

A few hundred people stood near Hong Kong's harbor to watch the ceremony. The crowd erupted with cheers when four helicopters carrying Hong Kong and Chinese flags flew over the area.

Since Hong Kong returned to China, the city has been governed under a "one country, two systems" formula. The arrangement has allowed the territory to keep its capitalist economy, British-style legal system, free press and civil liberties.

In many ways, Hong Kong has grown closer to the motherland - which has been vital in helping the city recover from the Asian financial crisis that erupted one day after the 1997 hand-over.

Hong Kong has become tightly linked to the mainland's galloping economy and has positioned itself as a key entry point to the Chinese market. Hong Kong companies are heavily invested in southern China's booming Pearl River Delta region, employing more than 10 million factory workers.