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Visitors pass in front of the Chinese telecom equipment group ZTE Corp's booth at the Mobile World Congress in Barcelona, Spain, Feb. 26, 2018.

Sergio Perez/Reuters

The United States has banned American firms from selling parts and software to China’s ZTE Corp for seven years, potentially devastating for the telecoms equipment maker and exacerbating tensions between the world’s two largest economies.

The move, first reported by Reuters, comes at a time when the two countries have threatened each other with tens of billions of dollars in tariffs in recent weeks, fanning worries of a full blown trade war that threatens global supply chains as well as business investment plans.

The U.S. Commerce Department imposed the ban following ZTE’s violation of an agreement on punishing employees that was reached after it was caught illegally shipping U.S. goods to Iran.

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China responded swiftly, warning it is prepared to take action to protect the interests of Chinese firms and saying it hopes the United States can deal with the issue in accordance with the law.

The U.S. action could be catastrophic for ZTE since American companies are estimated to provide 25 per cent to 30 per cent of the components used in ZTE’s equipment, which includes smartphones and gear to build telecommunications networks.

“If the issue cannot be solved smoothly and immediately, we think that ZTE will face tremendous disaster and would be forced to scale back on its smartphone business, not only in the U.S., but also in other markets,” said Strategy Analytics analyst Woody Oh.

ZTE, whose Hong Kong and Shenzhen shares were suspended from trade on Tuesday, said in a statement it was assessing the implications of the U.S. decision and was communicating with “relevant parties”.

The company has set up a crisis management group in response to the ban, said a ZTE source, declining to be identified as the information was confidential.

Particularly damaging, Google’s mobile services including the Google Play App Store are likely to be covered by the ban even though the Android operating system is free, said Richard Windsor, an independent analyst at Radio Free Mobile.

“I think that there is a risk that ZTE loses all of its non-Chinese Android business,” he said. “In almost every region outside of China, it is almost impossible to sell an Android handset that does not have Google Play installed.”

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Google declined to comment.

ZTE is China’s No. 2 telecom equipment maker after Huawei Technologies Co Ltd, the No. 4 seller of smartphones in the United States, and was worth some $20 billion as of Monday’s close. In 2017, it derived 59 per cent of revenue from its network business and 32 per cent from its consumer business.

“If the company is not able to resolve it, they may very well be put out of business by this. Many banks and companies even outside the U.S. are not going to want to deal with them,” said Eric Hirschhorn, a former U.S. undersecretary of commerce who was heavily involved in the case.

The Chinese company paid $890 million in fines and penalties after it pleaded guilty last year to conspiring to violate U.S. sanctions by illegally shipping U.S. goods to Iran.

As part of the agreement, Shenzhen-based ZTE promised to dismiss four senior employees and discipline 35 others by either reducing their bonuses or reprimanding them, senior U.S. officials told Reuters.

But the Chinese company admitted in March that while it had fired the four senior employees, it had not disciplined or reduced bonuses to the 35 others.

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FLASHPOINT SECTOR

Saying ZTE was likely to miss shipments and lose orders, brokerage Jefferies downgraded its rating on the firm to ’underperform’ from ‘buy’ and slashed its price target to HK$15.72, nearly 40 per cent below the firm’s closing price prior to Tuesday’s trading halt.

But Jefferies also said it expected ZTE would be able to settle with U.S. authorities in three to five months.

Under terms of the ban, U.S. companies cannot export prohibited goods, such as chip sets, directly to ZTE or via another country, beginning immediately.

As U.S. concerns about safeguarding its chip technology and cutting its trade deficit grow, the tech sector has become a flashpoint in the broader battle about trade and economic policy, with U.S. President Donald Trump accusing Chinese firms of intellectual property theft for years.

Washington has also deepened its scrutiny of Chinese investment in the U.S., with the Committee on Foreign Investment in the United States (CFIUS), blocking many proposed acquisitions of U.S. assets by Chinese companies.

Piling further pressure on ZTE, Britain’s main cybersecurity agency said on Monday it has written to organizations in the UK’s telecommunications sector warning about using services or equipment from ZTE.

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The ban on supplying ZTE comes two months after two Republican senators introduced legislation to block the U.S. government from buying or leasing telecommunications equipment from ZTE or Huawei, citing concern the companies would use their access to spy on U.S. officials.

“China does not play by our rules, and we must be vigilant against Chinese threats to both our economic security and national security,” said Republican Representative Robert Pittenger after the Commerce announcement. Pittenger is sponsoring legislation that would strengthen the U.S. national security review process for foreign investments.

U.S. firms are also likely to get caught in the crossfire, with the fallout set to hit Qualcomm Inc, which provides the lion’s share of chips inside ZTE smartphones. Qualcomm was not immediately available to comment.

Shares in optical networking equipment maker Acacia Communications Inc, which gained just under a third of its total 2017 revenue from ZTE, tumbled 35 per cent. Acacia said it was suspending affected transactions and assessing the impact.

Other optical component companies also slid, with Lumentum Holdings Inc falling 8.9 per cent and Finisar Corp dropping 4 per cent. Oclaro Inc, which got 18 per cent of its fiscal 2017 revenue from ZTE, lost 14 per cent.

ZTE has sold handset devices to U.S. mobile carriers AT&T Inc, T-Mobile US Inc and Sprint Corp. It has relied on U.S. companies including Qualcomm Inc, Microsoft Corp and Intel Corp for some components.

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