US-led chip ban heralds a turning point for China and Asia’s semiconductor industry

Amid the duo shocks of falling global demand and rising geopolitical tensions, the financial results of Asian chipmakers, such as TSMC and Samsung, point to further headwinds in revenue and investment. Such pressure is more than cyclical, as the US-led chip ban can bring more structural consequences. The Netherlands and Japan, the producers of lithography equipment and/or chemical materials for chipmaking, will join the US in its export ban. Although the exact rules are not finalized, there is no doubt that China will face more hurdles in achieving its self-sufficiency goal. In this note, we analyze the implications of a US-led chip ban on China and the spillovers in Asia’s semiconductor industry.

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Ever since?the US introduced the gaming changing CHIPS and Science Act in October 2022, it is taking more steps to restrict China’s chipmaking capability to 16nm or below, expanding from previous coverage. But a major deficiency is China can produce chips at 16nm with Argon Fluoride immersion (ArFi) deep ultraviolet (DUV) machines, but at a higher cost and possibly also a lower yield. As such, the nods from the Netherlands and Japan are more crucial than ever as they are leading in DUV production.

In the short run, a US-led multi-country chip ban will harm China's tech advancement. The impact can be huge as semiconductor has surpassed oil as its biggest import item since 2014. Foreign firms supplied 86% of China’s chipmaking equipment in 2022. The US is the biggest provider with 52% of market share, followed by 23% by Japan and 10% by Europe. Although Chinese firms have made progress, their market share only grown from 7% in 2017 to 14% in 2022, and most production is in the matured nodes. The bad news is ArFi technology is used down to 45 nm, and China risks freezing its expansion to processes larger than 45nm if it cannot access nor produce the equipment.

For the world, semiconductor equipment makers may face a cyclical revenue shock as they lose access to the Chinese market. China is the biggest chip equipment buyer, which peaked at 29% of total purchases in 2021 but fell to 26% in 2022. Sanctions have deterred China's ambitions, and it saw the first decline in equipment purchase in 2022 within the last decade. In 2022, the US has the biggest exposure to China at 27% of sales, followed by 23% in Japan and 14% in Europe. Still, the impact will be smaller than the headline estimates as foreign firms own 38% of fabs in China and some capacity may move to other locations.

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A coordinated US-led chip ban will bring winners and losers. Chipmakers with advanced processes (<=7nm) will be less affected as the tech capability is in the hands of a few players. The mid-tier matured nodes between 7nm and 45nm can benefit if the US successfully curbs China's production. As a result, it is likely to see China being pushed to the corner of mature nodes larger than 45nm, especially as it already has a market share of more than 30% in this sector and the entry barrier is much lower with existing equipment.

In the long run, it all depends on whether the West can keep its tech advantage and how fast China’s R&D can close the tech gap. It is for sure that the US-led chip will slower China’s ambition in expanding chip production capacity, regardless of whether the facilities are owned by Chinese or foreign firms operating in China. But it is also clear that China will step up its research and development (R&D) more than ever, and it has a high chance in expanding in matured nodes, which is still essential for many products and form 42% of total fabrication capacity in 2022.?One of the spotlights is on automobile chips since China is very dominant in this supply chain and has a higher chance of controlling a large part of the ecosystem, together with its leading role in rare earth material and?electric vehicle?production.

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Throughout the past decades, semiconductors have been dominated by the US, followed by Japan's leadership, and then South Korea and Taiwan's overtaking. Semiconductors fabrication requires experience (trials and errors) and an enormous integration of skills and expertise, meaning it is not easy to catch up alone as it is probably the best example of a globalized product. The world may be de-globalizing, but there is a limit in changing the current set-up artificially.

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All in all, a US-led multi-country chip ban will put China and Asia's semiconductor industry at a crossroads. Due to geopolitical risks, China will continue to invest and push for innovation in?two possible scenarios.

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The first is?China does not manage to move up the ladder?in producing semiconductors and it is cornered at mature nodes with limited progress in building its advanced equipment. This scenario will lead to overcapacity and price competition for mature nodes and hurt Asian chipmakers with current successes in related fields. The latter is true if mature nodes are not subjected to decoupling forces, which is likely. If there were policy moves, a separate ecosystem could be developed in ASEAN and India to serve the needs of the developed world.

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The second scenario is one in which?China moves up the tech ladder successfully. In this case, and in the light of protectionist measures remaining in place in the West, the world will end up in two separate technology ecosystems and standards based on advanced chips from China and the developed world. This scenario presupposes huge subsidies in this industry in both ecosystems and inefficiencies.

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