Earlier, a small number of protesters were kept away from the Hong Kong Convention Centre, where the inauguration of Tsang and his new cabinet was taking place.'Gradual development'
Leung Kwok-hung, an independent politician, burned his invitation to the ceremony after being refused admission on the grounds he could be a nuisance.
Hu told those allowed in that people had enjoyed "extensive democratic rights and freedoms" since Britain handed over the colony after 155 years.
He also spoke of a "gradual and orderly development of Hong Kong's political system," echoing comments that caused a storm of protest last month when Beijing said it would not back a quick switch to full democracy.
1841 - Hong Kong island settled by British.
1860 - China cedes Kowloon peninsula to Britain for all time.
July 1, 1898 - Britain begins 99-year lease on New Territories and 235 adjacent islands.
December 8, 1941 to August 14, 1945 - Japanese troops occupy Hong Kong.
December 19, 1984 - Margaret Thatcher, then British prime minister, and Zhao Ziyang, then China's premiere, sign accord to return Hong Kong to Chinese sovereignty on July 1, 1997.
September 18, 1995 - Pro-democracy candidates win sweeping victory in Hong Kong's last legislative election under British rule. China vows to disband legislature.
July 1, 1997 - Britain returns Hong Kong to Chinese sovereignty.
But he warned that the agreement which protects Hong Kong's way of life for the first 50 years under Chinese rule was predicated on Beijing's sovereignty.
"One country, two systems cannot be separated from each other," he said. "The one country means that we must uphold the power vested in the central government."
Tsang reiterated his pledge to create a more democratic system for Hong Kong as he was sworn in for another five-year term.
He said his new government would work to "develop the mode of universal suffrage that will best serve the interests of Hong Kong".
The Basic Law - the territory's constitution -states that Hong Kong shall become a full democracy but does not set out a timetable.
Hong Kong's chief executive is currently chosen by a committee of 800 mainly Beijing loyalists and only half the 60-member legislature is directly elected.
Hu missed the protest march, having returned to the mainland after presiding over the opening of a new crossing that links the territory with the Chinese town of Shenzhen.
"We were disappointed that Hu didn't stay and hear what the Hong Kong people are asking for," Jackie Hung of the Civil Human Rights Front, which organised the demonstration, said.
"He didn't want to open his heart and ears and listen to people's aspirations for democracy."Economic investment
Hong Kong's economy has become tightly linked to mainland China, with Hong Kong companies investing heavily in southern China's Pearl River Delta region, employing more than 10 million factory workers.
Meanwhile, tourists from the mainland have helped pull Hong Kong's economy out of the recession caused by the outbreak of SARS, or severe acute respiratory syndrome in 2003.
But mainland China is also one of Hong Kong's greatest competitors.
Shanghai's stock market is competing with Hong Kong for Chinese companies seeking new listings, and it's port surpassed Hong Kong's this year as the world's second busiest behind Singapore.
Another port in Shenzhen is expected to overtake Hong Kong next year. Since Hong Kong returned to China in 1997, the city has been governed under a "one country, two systems" policy.
The arrangement was put in place to allow the territory to keep its capitalist economy and British-style legal system when it returned to China.
For the most part, Beijing has honored its promise to let Hong Kong enjoy a degree of autonomy, but critics accuse Chinese officials of behind-the-scenes meddling.