I'm just learning about Azure so forgive me for my naivety. I work for a federal government that would be very hesitant to have their applications and data hosted in another country. Could a local company offer "Azure" services? i.e. could software developers in a government department build their applications and deploy them to the Azure cloud, ensuring that their data stays within the country? Or would they have to look at a non-Microsoft cloud provider?
Data and Compute will reside in the datacenter you specify. Blobs, Tables and Queues are also backed up automatically to a paired data center:
You can opt-out of cross-datacenter data backup if data sovereignty becomes an issue. Once opted-out, data would only be in the specified data center, and you'd need to handle DR on your own (by possibly backing up data to on-premises storage).
Aside from those 6 datacenters, Fujitsu runs a Windows Azure data center in Japan. See this press release for more info.