China is Planning to Purge Foreign Technology

and Replace With Homegrown Suppliers

By Bloomberg News Dec 18, 2014 1:13 AM PT

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China is aiming to purge most foreign technology from banks, the military, state-owned enterprises and key government agencies by 2020, stepping up efforts to shift to Chinese suppliers, according to people familiar with the effort.
The push comes after a test of domestic alternatives in the northeastern city of Siping that was deemed a success, said the people, who asked not to be named because the details aren’t public. Workers there replaced Microsoft Corp.’s (MSFT) Windows with a homegrown operating system called NeoKylin and swapped foreign servers for ones made by China’s Inspur Group Ltd., they said.
The plan for changes in four segments of the economy is driven by national security concerns and marks an increasingly determined move away from foreign suppliers under President Xi Jinping, the people said. The campaign could have lasting consequences for U.S. companies including Cisco Systems Inc. (CSCO), International Business Machines Corp. (IBM), Intel Corp. (INTC) and Hewlett-Packard Co.
“The shift is real,” said Charlie Dai, a Beijing-based analyst for Forrester Research Inc. “We have seen emerging cases of replacing foreign products at all layers from application, middleware down to the infrastructure software and hardware.”

Security Panel

China is moving to bolster its technology sector after Edward Snowden revealed widespread spying by the U.S. National Security Agency and accused the intelligence service of hacking into the computers of Tsinghua University, one of the China’s top research centers. In February, Xi called for faster development of the industry at the first meeting of his Internet security panel.
Foreign suppliers may be able to avoid replacement if they share their core technology or give China’s security inspectors access to their products, the people said. The technology may then be seen as safe and controllable, they said.
China ranks second behind the U.S. in technology spending, with outlays rising 8.1 percent to $182 billion last year, according to research firm IDC. The U.S. spent $656 billion, a 4.2 percent increase over 2012.
The push to develop local suppliers comes as Chinese regulators have pursued anti-trust probes against western companies, including Microsoft and Qualcomm Inc. (QCOM) Recent months have seen Microsoft’s China offices raided, Windows 8 banned from government computers and Apple Inc. (AAPL) iPads excluded from procurement lists.

Trade War

“I see a trade war happening. This could get ugly fast, and it has,” said Ray Mota, chief executive officer of Gilbert, Arizona-based ACG Research, who expects the issue to result in direct talks between the U.S. and China. “It’s not going to be a technology discussion. It’s going to be a political discussion.”
In September, the China Banking Regulatory Commission ordered banks and finance agencies to ensure that at least 75 percent of their computer systems used safe technology by 2019. The regulator called on financial institutions to dedicate at least 5 percent of their IT budgets towards the goal.
While the CBRC policy doesn’t make a distinction between foreign and domestic products, it says banks must favor companies who share their “core knowledge and key technology.” It also cautions banks from relying too heavily on one supplier.
Chinese firms, like Huawei Technologies Co. and ZTE Corp. (000063), have already begun to gain local market share at foreign rivals’ expense.
Inspur Group’s Inspur Electronic Information Industry Co. (000977) rose as much as 2.6 percent in Shenzhen before closing 1.5 percent higher at 39.54 yuan.
Beijing Orient National Communication Science & Technology Co. (300166), a provider of software products to phone companies and financial institutions, climbed 9.9 percent to the highest since its January 2011 listing. Sinodata Co. (002657), which provides technology services to the banking sector, added 9.8 percent.

Military Order

About 80 percent of banks’ core servers and systems are made by foreign brands, Yan Qingmin, a CBRC vice chairman, said Nov. 27 at a conference in Beijing sponsored by the news magazine Caijing.
“Most of China’s financial IT systems are from foreign countries,” Yan said. “From the perspective of national security, it poses potential threats to us.”
The CBRC may start accounting for banks’ use of Chinese technology in its regulatory reviews, the Shanghai Securities News reported Dec. 4.
Xi’s Central Military Commission issued a similar, although less detailed, order in October, according to a report in the party-run People’s Liberation Army Daily. That document described information security as key to winning battles.
Intel, Microsoft, HP, Cisco and Qualcomm declined to comment. IBM said it isn’t aware of any Chinese government policy against using its servers in the banking industry.
Industrial & Commercial Bank of China, the country’s biggest bank, deployed a new IBM mainframe in August, the two companies said.

Jilin Trials

Chinese companies have faced similar pressure overseas. A 2012 U.S. Congressional report said Huawei and ZTE, the country’s largest phone-equipment makers, provide opportunities for Chinese spies to tamper with U.S. communications networks. Huawei has since been shut out from several U.S. deals.
In May, the U.S. Department of Justice accused five men in the People’s Liberation Army of allegedly hacking into the computer systems of U.S. companies to steal information. The Chinese government called the charges “absurd.”
The orders from Chinese banking and military commissions coincided with the trial of domestic computer systems in Siping, a city of 3.4 million people in Jilin province. Other cities and agencies in Jilin will now begin testing whether NeoKylin, a Linux-based operating system from China Standard Software Co., can substitute for Windows and servers made by Inspur can replace IBM’s, the two people familiar with the plan said. The trial will then expand across the country, they said.

Domestic Software

Similar efforts were confirmed by one provincial-level worker and two local government workers in Jilin’s capital of Changchun, who asked not to be named while discussing internal matters. The two local government workers said some specialized software was swapped for domestic versions, including a tax program designed by the Harbin Institute of Technology.
China faces obstacles in replacing foreign software and hardware on a national scale. Almost three decades after paramount leader Deng Xiaoping approved his State Hi-Tech Development Plan, Chinese companies hold a fraction of global market share. They’re still unable to match the most advanced products, such as high-end bank servers.
“A key government motivation is to bring China up from low-end manufacturing to the high end,” said Kitty Fok, China managing director for IDC.
National security provides China a powerful rallying cry, particularly within its sprawling state sector. China National Petroleum Corp., the country’s largest energy producer, announced Nov. 26 -- during China’s first Cybersecurity Week -- that it had replaced its Microsoft e-mail with the homegrown eYou program to improve security.
“The technology gap is closing,” said Mota, who advises Cisco and HP, as well as Huawei and ZTE. “In China, they have the patience to figure it out.”
To contact Bloomberg News staff for this story: Steven Yang in Beijing at kyang74@bloomberg.net; Keith Zhai in Beijing at qzhai4@bloomberg.net; Tim Culpan in Taipei at tculpan1@bloomberg.net
To contact the editors responsible for this story: Nicholas Wadhams at nwadhams@bloomberg.net; Michael Tighe at mtighe4@bloomberg.net Suresh Seshadri

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