China options limited as U.S. panel outcasts Huawei, ZTE

Oct 9 (Reuters) - China's leading telecom equipment makersaccused in a U.S. congressional report of being a potentialsecurity risk may face fresh scrutiny in other markets, whileAmerican firms operating in China could be vulnerable toretaliation.

The U.S. House of Representatives' Intelligence Committee onMonday warned that China could use equipment made by HuaweiTechnologies Co Ltd and ZTE Corp- the world's second- and fifth-largest makers of routers andtelecoms gear - for cyber-espionage through software embedded inChinese-made network equipment.

In its 52-page report, the committee noted that "China'smilitary and intelligence services, recognizing thetechnological superiority of the U.S. military, are activelysearching for asymmetrical advantages that could be exploited inany future conflict with the United States. ... Maliciousimplants in the components of critical infrastructure, such aspower grids or financial networks, would also be a tremendousweapon in China's arsenal," it stated.

China's official People's Daily newspaper accused thecommittee on Tuesday of acting on a "presumption of guilt"against Huawei and ZTE. "This foolhardy political step ... willimpede the healthy development of Sino-American tradecooperation," said a commentary in the newspaper, whichgenerally reflects government thinking.

It added that the committee had produced "not an iota" ofevidence to back its accusation that Huawei and ZTE productswere used for espionage in the United States. "This report,which spurns the facts and is suffused with prejudice, is avicious expansion of trade protectionism," it said.


The blow-up - a Xinhua English-language commentary spoke of"a Cold War mentality" in the United States - comes at asensitive time for U.S.-China relations, ahead of U.S.presidential and congressional elections and a leadershiptransition in China.

Tensions have ratcheted higher with a series of tradeactions against China by President Barack Obama, including hisblocking of a privately owned Chinese firm from building windturbines close to a U.S. military site, and his challenge ofChinese auto and auto-parts subsidies in a World TradeOrganization (WTO) case.

His Republican opponent, Mitt Romney, says if elected hewill label China a currency manipulator from day one.

Ed Snyder, an analyst at Charter Equity Research in SanFrancisco, said the committee's report could lead to retaliationagainst U.S. companies that sell products in China in thetelecommunications industry and beyond. He mentioned CiscoSystems Inc , Google Inc , Qualcomm Inc, Apple Inc as examples, but said non-tech U.S.companies could also be hit.

"By calling them out like this, they're almost certain toget retribution," Snyder said. "There's a lot of ripe targets."

<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ U.S. report dashes expansion hopes GRAPHIC: Huawei/ZTE by numbers GRAPHIC: Huawei e-govt projects Ren pits Huawei against the world ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> BALANCED RESPONSE

Sun Lin, an independent telecoms consultant in Beijing,however, played down the threat of retaliation against U.S.high-tech firms, such as Cisco.

"We have to remember that on a technological level, China isno match. Chinese customers want state-of-the-art products. Insome sectors they can only come from the United States, Europeor Japan. If you shut down that source completely you will losein the end," he said. Cisco and Hewlett-Packard dominateChina's enterprise networking equipment market, where Huawei andZTE lag in the range of products and services they offer.

Sun said Beijing was likely to seek a compromise between apolitical response balanced against Chinese business interests."I do not believe we are going to see a substantial degree ofretaliation in China," he said, though he did not rule out apossible kick-back at the U.S. pharmaceuticals or agriculturesectors.

Rather than direct action such as raising tariffs on importsfrom the United States, China is more likely to "make life alittle more difficult" for U.S. firms operating there, saidEnzio von Pfeil, an independent economist in Hong Kong. "Itcould be a sort of whisper campaign (to discourage Chinese frombuying some U.S. products)," he said.

An executive from a major Chinese networking equipmentdistributor, which uses mainly Cisco products for its clients'enterprise networks, also said there was unlikely to be anysudden switch to Chinese products.

"Cisco has been in the market for many years and has built agood reputation. I don't think people will make the switch toother products immediately," said the executive, who is notauthorised to speak to the media and didn't want to be named."Maybe things will die down after the U.S. elections."


Similarly, few felt China would have much of a case if itwent to the WTO, which arbitrates in major trade spats.

"It's a political problem, not a trade problem," said TuXinquan, a WTO expert at the University of InternationalBusiness and Economics in Beijing. "Both governments are facingdomestic pressures. The United States is looking at Chinesecompetition more seriously and trying to do more to lower thecompetitiveness of Chinese companies, especially when many bigcompanies are related to the government. But those restrictionswill be counterproductive," he said.

The U.S. report capped an 11-month investigation that Huaweiitself had urged early last year, hoping such a probe wouldremove suspicions that killed its bids for U.S. communicationscompany 3Com and U.S. server technology firm 3Leaf.

The panel said it referred to the Justice Department andDepartment of Homeland Security credible allegations suggestingHuawei may be guilty of bribery and corruption, discriminatorybehavior and copyright infringement.

Huawei and ZTE, both based in Shenzhen in southern China,denied the allegations in the report, with Huawei spokesmanWilliam Plummer warning the panel's recommendations would set a"monstrous, market-distorting, trade-distorting policy precedentthat could be used in other markets against American companies."

In Hong Kong, ZTE shares fell by as much as 8 percent onTuesday, following Monday's 6 percent drop. The stock has morethan halved this year, underperforming the benchmark Hang Sengindex's 14 percent gain.


Employee-owned Huawei, founded by CEO Ren Zhengfei 25 yearsago after he was laid off by the Chinese army, has expanded inEurope and India, and says its products are currently used inmore than 150 countries. More than two-thirds of its annualrevenue of $32.4 billion is earned outside China.

Luke Coleman, media relations manager for Huawei Australia,said the company has "zero" Chinese government involvement, andthere should be no impact on its business in Australia, where itsupplies telecoms equipment and handsets and builds networks formobile operators such as Optus and Vodafone ,universities and a major state rail company.

Huawei, which has been barred from taking part in contractsto build the government's $38 billion national broadbandnetwork, had Australian revenue last year of A$229 million ($234million). "There's nothing new. From our perspective, this is atrade issue masquerading as a security issue," Coleman said.

A senior telecoms industry official in India - where Huaweihas sales of about $1.2 billion, excluding handsets - said thatwhile the government will watch the situation closely, businesswould still buy Chinese equipment, primarily because of price.

"For operators, the biggest draw for buying Chineseequipment has been the price point and the financing available.It'll be a difficult proposition (to not buy Chinese gear) whenthe whole industry is under liquidity stress," the officialsaid, declining to be named due to the issue's sensitivity.

In New Zealand, opposition parties called for an inquiryinto Huawei's involvement in building a government-sponsoredultrafast broadband network. The Chinese firm last year signedan equipment deal with network operator Chorus Ltd ,which is building most of the network.

"The taxpayer shouldn't be giving Huawei hundreds ofmillions of dollars to make it easier for Beijing to potentiallyspy on us," said Gareth Hughes, information technology spokesmanfor the Green Party. The government said the opposition waspainting "a misleading view of the situation".

(Reporting by Jim Wolf in WASHINGTON, Chris Buckley, BenBlanchard, Chyen Yee Lee and Michael Martina in CHINA, DeviduttaTripathy in NEW DELHI, Gyles Beckford in WELLINGTON and JamesGrubel in CANBERRA; Writing by Ian Geoghegan; Editing by KenWills)

((ian.geoghegan@thomsonreuters.com)(Reuters Messaging:ian.geoghegan.thomsonreuters.com@reuters.net))