That's all very true - the context in the early 1980s was that the UK government had only changed UK citizenship law to fully exclude the remaining colonies from citizenship in 1981 (which became effective in 1983); Enoch Powell was still an MP (albeit for the UUP not the Conservatives) and Commonwealth/colonial immigration in general was still seen by a large number of people as a problem, often for racist reasons.
But I don't think that's the whole story. Once the UK had conceded that it would hand over Hong Kong, it was determined to use it in a positive way - hoping that China would see the success of Hong Kong and try to emulate it, by liberalising its economy, rather than moving Hong Kong towards the Chinese system. Deng Xiaoping was relatively newly in power and economic liberalisation in China was no longer unthinkable. In the context of the cold war, encouraging this was an important strategic imperative which it's easy to forget now.
There were very real (and arguably very justified) fears that granting UK citizenship automatically would have led to a huge brain drain effect which could have harmed Hong Kong and frustrated this objective.
Of course, by the 1990s the Cold War was over and none of this was relevant any more. The decision to only offer 50,000 people full UK citizenship then was indeed a huge mistake and something we should be ashamed of - unfortunately it didn't get wide publicity in the UK at the time the decision was made and I think people are still very unaware of it.