China's chip suppliers have some growing up to do

All eyes are on China's semiconductor-equipment laggards. Beijing is readying a $144 billion fiscal package aimed at supporting tool and machinery manufacturers that are woefully behind Dutch and Japanese rivals. A combination of targeted subsidies and local demand will help. But catching up will be a years-long, if not decades-long, slog.

The planned measures mainly consist of tax credits and subsidies for Chinese companies to source equipment and tools locally, Reuters reported. They will be a much-needed response from Beijing: American officials have stepped up efforts to put pressure on governments in the Netherlands and Japan to restrict equipment exports to the People's Republic - part of Washington's campaign to hobble China's progress in developing high-tech chips. New curbs could be announced "in the coming weeks", Bloomberg reported on December 12.

China's dependence on foreign suppliers for lithography machines, used to print patterns onto silicon wafers, light-resistant wafer coatings known as photoresists and other vital tools cannot be understated. A 2021 report found that Chinese chipmakers buy less than a fifth of their equipment by value from local suppliers and that the country has localised less than 8 per cent of annual equipment demand. That leaves the sector heavily reliant on firms like Netherlands-based ASML (ASML.AS), which boasted a 91 per cent global share of lithography last year and a monopoly on the most advanced machines, and Tokyo Electron (8035.T), which similarly dominates the market for photoresists, according to Bernstein analysts.

Developing local alternatives will require more than just lavish government spending. That's a painful lesson Beijing has learned following last year's financial implosion of its erstwhile semiconductor champion Tsinghua Unigroup and a recent corruption scandal involving a $50 billion government chip fund. China's equipment specialists, such as little-known firms NAURA Technology Group (002371.SZ) and Advanced Micro-Fabrication Equipment (688012.SS), are probably too small to effectively absorb massive amounts of government funding anyway. A more targeted approach this time, such as incentivising demand for their products, looks more promising.

One reason is that having chipmakers and their equipment-suppliers in close proximity to each other can help accelerate collaboration in research and development. ASML, for example, already boasts five factories in Taiwan, home to its top customer TSMC (2330.TW), and has plans for another in 2023, per local media reports. For peers in China, there’s still a long way to catch up.

China is readying more than 1 trillion yuan ($144 billion) of fiscal support for its semiconductor industry, Reuters reported on Dec. 14, citing sources.

The majority of the funds will be used to subsidise the purchase of domestic semiconductor equipment by Chinese chipmakers. Qualified companies would be entitled to a 20 per cent discount on the cost of purchases. Other measures include preferential tax policies for the industry.

Separately, White House National Security Adviser Jake Sullivan said on Dec. 13 that discussions have taken place with Japan and the Netherlands - both major suppliers of chipmaking equipment - on adopting Washington's new technology export restrictions, unveiled in October, against China.