China – Taiwan Conflict: Potential Impact on Economies and Supply Chain

As Russia – Ukraine war rages in Eastern Europe, we should also keep an eye on the China – Taiwan tensions in the far east.  CIA director, William Burns, mentioned that the difficulties encountered by the Russian troops in Ukraine has caused concerns in China. However, he added that the Chinese leader Xi Jinping’s determination of reclaiming the territory—that they consider as a breakaway province—must not be “underestimated.”

The statement showcases that the possibility of another military invasion—which could disrupt the already-strained supply chain—is still alive. Burns made the assessment at an annual U.S. House of Representatives Permanent Select Committee on Intelligence hearing on worldwide threats, which was also attended by several other intelligence chiefs.

In light of this assessment, Beroe has released select analysis of supply chain and category impact if conflict breaks out between China and Taiwan. If you need to know more, please write to contactus@beroe-inc.com

Taiwan has been governed, independently of China, since 1949. However, Beijing still claims Taiwan to be a part of Mainland China. Chinese military pressure on Taiwan has intensified and concerns of a war erupting between Taiwan and China surround the globe, with the U.S. supporting Taiwan on the defense front by supplying weapons. However, the U.S. still relies on the “One-China Policy”—recognizing China and Taiwan as one country—and has ties with China rather than Taiwan.

Taiwan and International Relations

• Taiwan is not a member of the UN as China has not approved its participation. Taiwan is also not allowed to participate in the WHO and other international organizations, limiting its membership to states.
• However, it holds membership in 40+ organizations, most of them being regional, including the Asian Development Bank, Asia-Pacific Economic Cooperation Forum, and World Trade Organization.
• Taiwan also holds diplomatic ties with 15 regions in East Asia, Africa, and the Caribbean countries.

China’s Intervention in Taiwan’s Politics 

China has adopted various tactics to wear down Taiwan’s government. Some of them include:

• Frequent cyber attacks since 2016 when Tsai was elected as the president.
• Spreading of misinformation about the Taiwanese presidential candidate at the time of the elections.
• Political criticism over Taiwan’s mishandling of the water crisis, COVID-19 pandemic, and power outages.

Taiwan – China Conflict and Dependence 

• Amid drought in Taiwan, China’s provision of water and other major Cross-Strait infrastructure projects indicate the future dependence of Taiwan on China for integrated development.
• China has also increased its usage of army bombers, fighter jets, war ships, and surveillance aircrafts over and around Taiwan. Non-military measures, like the restriction of Chinese tourism to Taiwan, are also expected to hinder the economic prospects of Taiwan.

China – Taiwan Escalation and its Impact on Global Economies 

Trade and external relationships have been deteriorating with rising tensions over China’s over-powering strategies. Near term outlook for Taiwanese trade seems to be favorable. However, long term outlook stresses the need for diversification to enhance business.Despite Chinese threats, Taiwanese democracy remains strong, evident from the “Economists – Democracy Index,” which ranked Taiwan as the 11th most democratic country—higher than other Asian peers and the U.S.

High uncertainty, geo-political risks, and the long, unresolved status of Taiwan have kept the economy under a dangerous flashpoint in the APAC region.

Japan

• Chinese annexation of Taiwan may lead to negative effects in the Japanese islands, viz., Yonaguni, the Senkaku/Diaoyu Islands, and Okinawa, affecting the tourism sector of Japan.
• Forty percent of Japan’s sea trade passes though the South China sea. If China takes control of Taiwan, it would probably impose shipping limits, hindering Japan’s trade and economic growth.
• Given the close proximity to Taiwan, escalation of conflicts and a war situation will lead to an import-dependent economy in Japan.
• China is Japan’s major trading partner and if Japan supports Taiwan, China would impose trade restrictions, curtailing economic growth.
• On the other hand, if Japan fails to assist the U.S. in supporting Taiwan, it could harm the U.S.–Japan alliance.

U.S.

• The Biden Presidency is likely to take a stance in favor of Taiwan. It stated that “its commitment to Taiwan is rock solid”.
• Taiwan is the major supply source of semiconductor chips for the U.S. tech companies, including Apple. This dependence—coupled with TIFA talks—could heighten the motive for the U.S. to defend Taiwan in the conflict with China, and deepen U.S.–Taiwan ties.
• TIFA talks include two major areas of concern—global semiconductor supply and COVID vaccines—which should boost ties between the U.S. and Taiwan in the near future.
• The U.S. would more likely focus on the diversification of supply chain from China to reduce dependence and sustain economic growth.

Australia

• Australia has signed a defense and trade pact with the U.S. and the UK, called “AUKUS”—including nuclear submarines—which China considers an arms race. Australia has vowed to support Taiwan.
• Australia has been facing increasing restrictions and friction with China over the past few years, which has impacted the trade growth prospects. Escalation and retaliation by China would impact Australian exports, including agriculture and mining, while retail, construction, and manufacturing industries would suffer from loss of Chinese imports.

India

• Like other major nations, India does not hold formal diplomatic ties with Taiwan. However, informal ties have been strong since the mid-1990s. India’s support to Taiwan could mean a potential tie that would help India establish semiconductor plants. By contrast, with the already existing border tensions with China, India might face challenges from China, which could have a major impact on India’s chemicals and pharma sector, considering the current dependency.

Impact on Supply Chain and Business

Semiconductors

• Taiwan is the largest producer of electronic chips, which are supplied to almost all the industries, from phones to laptops, watches to game consoles, industrial equipment to automotive, and aircraft and fighter jets.
• TSMC (Taiwan Semiconductor Manufacturing Company) is the largest foundry in the world and holds around 65 percent of the global production of chips.
• Any potential conflict with China would completely disrupt the entire supply chain of TSMC and labor availability, and could cause major shortage of electronic chips.
• Additionally, China controls five percent of the global production of chips, which could also be affected.
• This could further impact the already existing supply-demand gap for electronic components.

Opportunities

• At present, China can meet only 15-20 percent of the global semiconductor demand, and relies on Taiwan and South Korea for most of its semiconductor chip imports and electronics manufacturing.
• Since early 2021, Taiwanese companies started shifting from China, reportedly due to rising costs of doing business and trade tensions.
• As part of the U.S. Strategic Competition Act of 2021, companies located in China—with a majority of U.S. clients—will need to diversify their supply chain.
• In the long term, a decline in investments and investment-led trade between Taiwan and China is expected, which would assist Taiwan to secure a stronger supply chain position. 

Risk

• Taiwan’s economy is highly reliant on trade with China and the Middle Kingdom contributes a major share in Taiwan's trade.
• Despite Taiwan’s efforts to tackle China on the political front, Taiwanese economic growth is still highly dependent on China, which is evident from the trade numbers.

Recommendation

• Diversification of trade and supply chain is essential for Taiwan for a smooth economic growth amidst rising tensions with China.
• Businesses are advised to look for alternate suppliers—like South Korea—for semiconductor chips and intermediate electronic goods to deal with any supply chain issues.

  Agro Commodities

• Fresh fruits is the largest export category for Taiwan within the agro space. The country exports large volumes of fresh pineapples, sugar apples, citrus fruits, mangoes, wax apples, pomelos, ponkan, grapes, bananas, and grapefruit. China buys over 80 percent of all the fruits exported, followed by Japan and Hong Kong.
• If China decides to invade Taiwan, the impact will be minimal on the countries that import these fruits. These are fruits available in abundance in many other countries, and importing countries could source them from other top producers.
• In case of a war, Taiwan will not be able to export their fruits to China or any other country. There will be an over-supply of these fruits within Taiwan, which might result in wastage due to lagging infrastructural support to store these fruits.
• Hence, any kind of supply chain disruption caused due to Chinese invasion will impact only these two countries in the agro commodities space.

Data Center Hosting Services

Current and Prospective Geopolitical Scenario

• On Feb. 23, Taiwan issued an official condemnation to Russia on the infringement of Ukraine’s sovereignty and has reiterated its effort to bolster military readiness. On the same day, China’s foreign minister and their official news media—The Global Times—confirmed China’s intention of reuniting Taiwan with the Mainland. The official news agency has also stated that China requires Russia’s support to resolve the Taiwan crisis effectively.
• During February 2022, China beamed military laser from its destroyer on the Australian Surveillance Aircraft, demonstrating its increased belligerence. In addition, former Japanese Prime Minister, Shinzo Abe’s suggestion of Japan housing U.S. nuclear weapons—especially post the Ukrainian invasion—has drawn ire from China, creating a tense geopolitical situation in the entire South China sea belt.
• China has taken notice of the fact that the sanctions from the West have impacted 70-80 percent of Russian banking assets. In addition, Australia, New Zealand, Singapore, Japan, and South Korea have also imposed sanctions against Russia. However, China is also observing that countries like Saudi Arabia, Israel, India, and several African countries are treading the non-alignment path.
• In an unofficial capacity, several former U.S. officials visited Taiwan in the first week of March and affirmed commitments of the U.S. towards Taiwan. This statement indicates that the U.S. is not willing to treat Russia and China at the same level, indicating a relatively aggressive posture of the U.S. in the South China sea. Ely Ratner—the assistant secretary of defense for Indo-Pacific affairs—has also mentioned Taiwan to be “pacing” scenario in the Indo-Pacific.
• There is a probability of China attempting to launch a military operation over Taiwan during the first fortnight of April, primarily due to the posture of the U.S. in the region and the lesser odds of the West issuing proper sanctions on China as it has already been cut-off from Russia’s imports.

Impact on Supply & Demand: High 

Taiwan accounts for around 63 percent of semiconductor production in the world. With the Russo-Ukrainian conflict already impacting the semiconductor supply chain—as it hinders neon gas and palladium supply for semiconductors—any aggression over Taiwan would further affect the supply of semiconductors for data centers.

Impact on Price:High

The price of data center hosting services would escalate exponentially, possibly drawing parallel to the price rise during the 2011 floods in Taiwan. In case of any military aggression, the demand for data center infrastructure would increase significantly—especially in the U.S., Europe, and the Asia Pacific—as vendors would look forward to higher levels of inventory at their disposal.

Impact Duration:High

Based on the NOTAM notice issued by Russia for Ukraine, it was clear that the Russians expect the war to prolong till May. However, any invasion in Taiwan is likely to be scheduled for a month and price hike would continue till the first half of 2022.

Personal Computing

• On the day when Russia invaded Ukraine, Taiwan’s Defense Ministry issued a statement that nine Chinese aircrafts had intruded into the air identification zone of Taiwan. This acts as an indicator of China’s intention towards unifying Taiwan.
• China’s foreign minister, Wang Yi, has warned the U.S. against the formation of Pacific NATO and the support the U.S. is extending to Taiwan. Chinese statements—expressing concerns over the U.S. alliance in the region—were almost similar in tone to Putin expressing concerns regarding NATO since November 2021.
• During early 2021, former national security adviser of the U.S., General McMaster, has stated that Taiwan’s sovereignty is in danger, starting 2022, mentioning that Mainland China would attempt a military invasion post the Beijing Winter Olympics. It is likely that China may view the division of resources in the West—due to the ongoing military war with Russia—as a conducive window to attempt a military takeover of Taiwan.
• There is a high likelihood that China will attempt to launch a military operation over Taiwan during the first fortnight of April, primarily because of the posture of the U.S. in the region and the lesser probability of the West issuing proper sanctions over China as it has already been cut-off from Russia’s imports, the economic impact of which is still unclear.

Impact on Supply & Demand: High

Taiwan and South Korea account for around 63 percent and 18 percent of semiconductor production in the entire world, respectively. Any military aggression in the South China sea will cripple around 80 percent of the production capacity, severely impacting personal computers that are facing order backlogs due to the existing semiconductor shortage.

Impact on Price: High

It is possible that prices of personal computing devices—such as laptops and smartphones—would grow rapidly. In the event of a military attack, the demand for semiconductors—a key component in personal computing products—would drastically increase across the world, and the price impact would exist till the market completes the transition from a cheap supply chain to a safe supply chain.

Impact Duration: High

Aside from geopolitical uncertainty, the loss of production capacity—coupled with transportation delays in the South China sea region—might exacerbate the situation. It is highly unlikely to estimate the impact duration of this prospective military operation.

Energy

In the event of any conflict, we do not anticipate any possible sanction on energy commodities. More plausible are sanctions on RE technologies, which could trigger global shortages in the short and medium term. Price and supply risk of energy commodities is already very high and periodic monitoring is recommended. Preference to suppliers from different geographies and partnering with emerging suppliers for Renewable Energy (RE) is highly suggested.

Chemicals

Diversification of supplier base is highly recommended for critical categories. Regional supply base with preference to suppliers present in multiple locations/regions is highly suggested. Price and supply risk would be very high and periodic monitoring of key categories is recommended.

Metals 

China accounts for over 60% of global supply for all known metals, minerals and Ores indirectly. If a crisis is to breakout, we do not anticipate any possible sanction on Chinese firms. However, a chocked South China sea may spiral up the lead time.