IBM Chairman and Chief Executive Sam Palmisano gestures during a meeting in Shanghai June 2, 2010. REUTERS/Aly Song SINGAPORE (Reuters) - U.S. technology companies including Cisco Systems Inc and IBM Corp are facing unprecedented difficulties selling their goods and services in China, as fallout from the U.S. spying scandal starts to take a toll.

Cisco said on Wednesday that its revenue would drop 10 percent this quarter, and continue to contract until the middle of 2014, in part due to a backlash in China against revelations about U.S. government surveillance programs worldwide.

"The U.S. government isn't doing any favors for Cisco," said Evercore Partners analyst Mark McKechnie, after the company's shares fell 10 percent in late trade.

In June, former National Security Agency contractor Edward Snowden revealed the spy agency had hacked network backbones around the world to gain access to sensitive information.

The leaks provoked a storm in the Chinese media and added urgency to Beijing's efforts to use its market power to create indigenous software and hardware capabilities, analysts and businessmen say.

"This is all about China using its own technology, and China building leading technology companies," said James McGregor, chairman for Greater China at consultancy APCO Worldwide.

In a call with analysts, Cisco Chairman John Chambers said Cisco "and our peers" were facing "challenging political dynamics" in China.

One of those peers, IBM, reported in October a 22 percent drop in China revenue, leading to a decline of 4 percent in third-quarter profit for the world's biggest technology services company.

IBM Chief Financial Officer Mark Loughridge attributed the company's problems to the "process surrounding China's development of a broad-based economic reform plan", which caused state-owned enterprises and governments to delay purchasing.

The company subsequently reassigned the head of its growth markets unit. IBM declined to comment for this story.

FOREIGN COMPANIES MISTRUSTED

Beijing has long mistrusted foreign technology companies, China executives said, and the Snowden revelations have exacerbated those concerns.

Although Beijing has not prohibited state firms from purchasing Western-made technology services and equipment, the government has sent a clear message to chose Chinese-made equipment first, China-based executives say.

"While a formal document hasn't been issued, in the future we will try to buy IT equipment from domestic brands, such as Lenovo," said a person familiar with technology purchases at one of China's four big state-owned banks.

"The government's signal is pretty clear - they want to rely less on U.S. products, such as IOE (IBM, Oracle and EMC Corp," said a former China-based telecommunications executive.

Beijing is especially focused on security for government, energy, transport, and finance networks.

In August, the National Development and Reform Commission, China's top economic planning body, published a statement setting cyber-security standards for financial institutions, cloud computing and big data, information system secrecy management and industrial controls.

Four domestic software and hardware makers, including China National Software & Service Co., announced this month they have received a "top-tier" rating from the Ministry of Industry and Information Technology.

China National Software's share price has gained nearly 250 percent since Snowden first revealed the existence of the NSA's clandestine data mining program in June.

LONGSTANDING RIVALRY

"We hope and demand that relevant foreign companies respect China's laws," Chinese Foreign Ministry spokesman Qin Gang said on Thursday, when asked about Cisco's woes.

"At the same time, as the Chinese government we of course have an obligation, a responsibility, to protect the country's security."

Cisco's problems in China have been particularly severe due to the San Jose, California-based company's longstanding rivalry with Huawei Technologies Co Ltd, which has faced stiff political opposition to selling equipment and buying companies in the U.S. telecom market.

In October 2012, Mike Rogers and Dutch Ruppersberger, the chairman and ranking member of the House Intelligence Committee, urged U.S. companies to stop doing business with Huawei, the world's second-biggest telecom equipment maker, and a second Chinese vendor, ZTE Corp, citing security concerns.

Snowden's revelations have reverberated in other big emerging markets such as Brazil, Mexico and India.

Chief Financial Officer Frank Calderoni said China was where Cisco was most affected by a political backlash, but noted that it was difficult to quantify how much of its revenue shortfall was due to politics versus macroeconomic trends.

"Between economic and political issues that are occurring in emerging markets we had a significant impact," Calderoni told Reuters in an interview.

China-based executives say that the impact of China's localization drive was expected to be uneven in the months and years ahead.

For telecommunications equipment, for example, domestic carriers will look to buy products from Huawei and ZTEover Sweden's Ericsson or Cisco, the former telecoms executive said.

Huawei, too, is making rapid progress in its server business, with shipments jumping 258 percent in the second quarter. IBM saw its market share shrink to 13 percent, from 18 percent, during the same period, according to Jefferies LLC.

Huawei now is the second-biggest server vendor in China's double-digit growing market, behind Dell Inc, which retains a market share of 23 percent but is growing at a rate beneath the market's 15.4 percent pace.

For other hi-tech products, including chips and database solutions, China will need more time before its products will be competitive.

"Everyone is feeling the heat from the NSA revelations," said a former employee at a major multinational technology firm. The important point, however, was that companies like IBM don't have competitors for their high-end equipment, the expert added. "If they don't buy from IBM they can't buy from anyone else."

(Additional reporting by Sinead Carew in New York, Michael Martina in Beijing, Jeremy Wagstaff and Lee Chyen Yee in Singapore and Beijing newsroom; Editing by Alex Richardson)