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American and Russia are teetering on the brink of a new Cold War, economically

America's economic battle with Russia heated up on Thursday following the crash of Malaysian Airlines (Malaysia Airlines System Bhd (MK:MAS)) Flight 17, which was downed near Donetsk in East Ukraine, apparently from some sort of surface-to-air missile.

I. Obama Administration Escalates Conflict With Russia

Earlier this week rebel forces controlling the crash site in East Ukraine handed over black boxes from the flight and bodies of flight victims recovered from the site.  But the situation remains tense amid conflicting perspectives.

Russia continues to adamantly accuse the Ukranian government of doctoring evidence, suggesting the western-backed government of west-Ukraine or mercenaries in its employ may have shot down the jet.  The U.S. has said that a growing body of evidence points to Russian-backed militants in East Ukraine as the likely culprits.  It suggests they may have downed the jet using advanced air defense systems provided by Russia.

While Russia joined calls by America and much of the EU for a cease fire in war-torn eastern Ukraine, that did not halt the U.S. from rolling out an upgraded set of economic restrictions last Thursday.  Now Russia has responded, and several top U.S. tech firms are caught in the cross fire.

MH-17 bodies
A train transporting the bodies of MH-17 crash victims prepares to depart for Western Ukraine.
[Image Source: Ria Novosti]

Thursday's restrictions target several of Russia's largest corporate-government entitties, including:
  • ENERGY
    • Rosneft NK OAO (MCX:ROSN)
      • oil giant, coowned by Russian government
    • Novatek OAO (MCX:NVTK)
      • another Russian natural gas firm
  • BANKING
    • Gazprombank
      • investment wing of largest natural gas producer in Russia, Gazprom OAO (MCX:GAZP)
    • Vnesheconombank (VEB)
      • Russia's state development bank which facilitates overseas exports
The targeted corporations were added to the U.S. Department of Treasury Office of Foreign Assets Control's (OFAC) Global Sanctions List [PDF].  The firms have been banned from doing business using U.S. currency.  They've also been barred from buying all but the shortest forms of U.S. debt (3-month bonds).

Samuel Charap, a former Obama administration State department official and senior fellow at the International Institute for Strategic Studies (IISS), was pessimistic about the outcome of the financial volley.  He remarked to Bloomberg Businessweek:

This is certainly a major escalation... I’m not sure we can inflict enough pain to make losing Ukraine palatable to Moscow.  It’s hard for us to imagine how important Ukraine is to them and how far they’re willing to go. The question on a strategic level is ‘How far is the U.S. willing to go?’

Others believe the new sanctions could be painful enough to Russian corporations and their business partners to force them to back down.  David Riedel, President of the Riedel Research Group, which calls itself a global indepedent investment equity research firm, wrote to Bloomberg Businessweek:

[Russia] is teetering on the edge now and this will be enough to push it over.

But if Russia is going over the edge, it looks intent to go down kicking and screaming.  And U.S. companies are growing very concerned.

II. American Business Trade Groups Warn Moves Will Cost U.S. Jobs

Even before the crash of MH-17, the Obama administration had for weeks been threatening the kinds of OFAC punishments it doled out last Thursday.  

Two top business advocacy groups -- the U.S. Chamber of Commerce and National Association of Manufacturers (NAM) -- pleaded with the White House to reconsider, even going as far as to take out advertisements in The New York Times.  NAM official Linda Dempsey wrote:

Any manufacturer that has any office in Russia that uses a Russian bank would no longer be able to transact normal business, meet payroll, pay invoices.

Obama face
U.S. trade groups say antagonizing Russia will cost Americans jobs. [Image Source: Reuters]

The U.S. Chamber of Commerce elaborated:

We are deeply concerned by events in Ukraine and Russia. In no way do we condone Russia’s actions, but we respectfully oppose legislative proposals to impose unilateral economic sanctions on Russia.
 
We believe history has shown that unilateral sanctions consistently fail to achieve their intended objectives, which is why many leaders of both parties have expressed a principled opposition to these measures as a tool of American foreign policy.
 
U.S. unilateral sanctions will have no meaningful impact on Russian policy as trade with the United States accounts for less than 5% of Russia’s international commerce. The Ukrainian people would see no benefit; the only effect of such sanctions would be to bar U.S. companies from the Russian market and cede business opportunities to firms from other countries. The result would be lost sales for U.S. firms and lost jobs for American workers.
 
We understand the impulse to act. However, actions that are certain to be ineffective—doing nothing to promote stability while nonetheless costing American jobs—should be rejected.

Both groups warned that the sanctions could cost the U.S. jobs.  They have fallen more quiet in the wake of the MH-17 disaster, though, as calls to punish Russia for assisting rebels have grown.

III. Who Will be Affected

Now those fears are being put to the test.

Russia's state Duma -- the lower house of its bicameral legislature -- is drafting a bill that is expected to pass, ordering Russian government agencies and state-owned/-co-owned business to give domestic firms "preference" over foreign computer software and hardware from the U.S., Europe, or Asia.

It will be some time after the bill passes before the full impact of the measure becomes clear.  On the surface it somewhat similar to laws already on the books in regions like China, which favor domestic firms over foreign entrants.  Further, the protectionist bid may be limited by the number of proven alternatives to products form top U.S. firms.  Russia will be taking a substantial risk if it switches its government networks and enterprises over to use less secure or reliable solutions.

On the other hand, there may be some true motion away from U.S. offerings.

Microsoft Corp.'s (MSFT) SQL Server, Office, Windows, and Windows Phone products are used in Russia (among other software offerings) are expected to potentially be hit the hardest in the tech space.  According to some sources, Microsoft's Nokia Devices unit is the top smartphone maker in Russia, making this one of its most coveted sales regions.  

Russia Windows Phone
Microsoft's is the top smartphone maker in Russia.  [Image Source: WP Central]

Oracle Corp. (ORCL) (an IT/database solutions provider) and International Business Machine Corp. (IBM) may also be adversely impacted.

According to a Duma commision led by executive secretary Andrey Chernogorov, Russia currently awards 67 percent of software contracts and 90 percent of hardware contracts to foreign firms.

According to CNews Analytics, Russia has a number of large IT companies with revenue of over $1B USD which may be able to step up to the plate.  Among them are:
  • NCC (National Computer Corp.)
  • LANIT
  • Technoserv
  • Reksoft
  • NVision Group
  • IBS Group Holding Ltd. (IBSG) (ETR:ISBG)
It should be noted, however, that much of these companies' current services rely upon solutions involving American products, solutions that would not appear to be favored under the pending bill.

IV. The Spying Issue

Secretary Chernogorov says the bill is absolutely related to recent U.S. sanctions, stating to Bloomberg in an interview:

This all has to do with sanctions.  Given the current international tensions, substituting imports with local software and hardware becomes the key to ensuring self sufficiency.

But the Russian legislature has also said that a key concern is ongoing reports of the U.S. National Security Agency (NSA) spying on foreign economic rivals (both enemies and allies alike) using bugs, backdoors, and other security holes.  Much like the criticism that surrounds tech corporations in China -- another top tech and spying superpower -- American tech products are viewed globally as less trustworthy.

Russia is not alone in expressing concerns that the U.S. federal government could exert pressure on tech firms to help it spy; China, Brazil, and Germany -- among others -- have expressed similar fears.  Even if the tech firms don't directly assist the U.S. government in spying on foreign countries, the fact that the products are shipping through American controlled channels raises the risk that the products will be intercepted and implanted with bugs -- a popular tactic used by the NSA to spy on Americans and foreigners alike.  The NSA reportedly has entire factories devoted to such efforts.

NSA spying
Many are afraid American products will be used as spying tools. [Image Source: Nation of Change]

Russia knows a thing or two about surveillance.  It has faced a number of accusations of cyberspying in recent years.

Still, not all in Russia are convinced that abandoning proven U.S. solutions is a viable approach.  Nikolay Komlev, executive director of the Russian Association of Computer and IT Enterprises (an organization that expresses both domestic and foreign firms operating in Russia) commented:

The idea of supporting local IT production is justified.  Still, its implementation proposed by State Duma may give a competitive advantage to not the most efficient companies.

Under this new-look foreign policy, the Obama administration hasn't hesitated in playing hardball with a number of countries like Russia and China, even as it continues its massive spying campaign.  The impact of this shift will likely be closely scrutinized in 2016 when the President leaves office.

Sources: Bloomberg Businessweek [1], [2], NPR





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