China’s Tech Distress Grows as U.S. Chip Sanctions Bite

Semiconductor imports to China are falling. Chinese companies say they are struggling to get key components and machinery. And chipsets that have been remodeled to make them less powerful so they fall within U.S. rules are now threatened by the possibility of additional restrictions.

The distress signals show Washington’s nine-month-old policy of denying Beijing access to the most advanced semiconductors and the tools to make them is starting to bite, despite loopholes and workarounds keeping some key components flowing.

The restrictions also show the obstacles facing China in developing domestic alternatives for some of the most sought-after foreign semiconductor technologies.

“The controls appear to be making it harder and costlier for China to gain certain inputs,” said Emily Benson, a senior fellow specializing in trade and technology at the Center for Strategic and International Studies think tank.

Customs data released by Beijing this month highlighted the reality for Chinese buyers of high-end chips: Imports of semiconductors fell by 22% in value terms during the first six months of 2023 from a year earlier. Imports of chip-manufacturing equipment dropped by 23%, extending last year’s decline.

Leading chip-manufacturing regions accounted for the lion’s share of the decline in semiconductor imports. Taiwan, home to Taiwan Semiconductor Manufacturing Co., the world’s largest chip maker, accounted for about 40% of the drop in China’s chip imports during the first five months of the year. South Korea, home to Samsung, SK Hynix and other chip giants, accounted for almost one-third. The U.S. restrictions affect foreign companies that use U.S. chip-making tools—which virtually all of them do.

There are likely other factors at play behind drooping semiconductor imports. China’s economy is slowing amid weaker global demand. Beijing has also invested heavily in domestic technology industries in a push for greater self-reliance, though that will take time to bear fruit. In the meantime, China lacks the ability to make the most advanced chips, with key elements in their supply chain controlled by the U.S. and its allies.

Japan on July 23 restricted the export of crucial semiconductor-manufacturing equipment, following curbs announced by the Netherlands. The two countries, with the U.S., are the only makers of some machinery essential to manufacturing the most advanced chips.

This month, the largest listed subsidiary of Inspur, China’s top maker of servers used to develop AI, issued a warning to investors: Citing tight supply, the company said it is struggling to get chips critical to powering its AI servers, the powerful machines used in laboratories and tech companies to develop advanced AI. The company said it could take a 30% hit to its revenue in the first half of the year as a result.

Unable to access the latest chips, China’s AI contenders risk falling behind in a sector that Beijing has said it aims to lead the world in by 2030. UBS said it expects global demand for AI products to reach $300 billion by 2027, from $28 billion last year. Meanwhile, U.S. tech giants including Microsoft, Google and Amazon are pumping billions into AI platforms unhindered.

Other Chinese companies are facing challenges getting parts. Late last month, China’s leading maker of memory chips, Yangtze Memory Technologies, urged suppliers to show “integrity” and deliver machinery parts it had already purchased.

“We can’t get the components, which we have bought legally,” said Nanxiang Chen, chairman and acting chief executive of YMTC, which is among the companies cited by the U.S. that can’t receive exports from America or its allies.

A major Chinese tool maker at the same industry event in Shanghai said it must now apply for licenses through its U.S. suppliers to obtain certain components. The license application procedure can take months, and there is no guarantee of receiving the components in the end, an employee at the Chinese tool maker said.

The U.S. export rules announced Oct. 7 included caps on the power of certain processors used in AI applications and in supercomputers, as well as restrictions on the types of chip-making machinery, components and software China can import.

While selling top-end chips and tools to Chinese buyers may no longer be an option, some Western companies are benefiting from China’s accelerating buildup of domestic chip capacity. ASML, the Dutch maker of lithography machines that are critical to chipmaking, posted a 27% rise in second-quarter revenue, driven in part by sales to China, its third-largest market during the period.

CEO Peter Wennink said China’s demand for less-advanced machines that aren’t affected by sanctions, is “very sustainable for the next couple of years,” because Chinese companies are investing in new factories to reduce reliance on imported chips.

At least two U.S. chip giants have tweaked the specs on products to meet export-control thresholds. Nvidia last year released a chip for the China market called the A800, a downgraded version of a high-end AI chip. It followed with another China-focused chip called the H800.

Earlier this month, Intel executives said the company was releasing a tweaked version of its Gaudi2 AI chip for the China market. Intel said it was joining with Inspur to offer the chip.

Despite the new chips, Handel Jones, CEO of consulting firm International Business Strategies, said Inspur appears to be having “major problems” getting high-end processors from chip makers including Intel, AMD and Nvidia, and called Intel’s new chip a “minor step” that could invite pressure from Washington.

The Biden administration is weighing further restrictions, including tighter exports to China of chips used in artificial intelligence, The Wall Street Journal has reported.

“Whether the controls remain successful or whether they inadvertently accelerate Chinese indigenization efforts” remains to be seen, said Benson from CSIS.

On July 3, China said it would restrict exports of gallium, used in some advanced semiconductors. More recently, China’s ambassador to the U.S., Xie Feng, threatened further retaliatory action, saying that Beijing “won’t flinch from any provocation.”

“It is like restricting the other side to wear outdated swimwear in a swimming contest, while you yourself are wearing a Speedo Fastskin,” Xie said, referring to what the iconic sportswear brand calls its most technologically advanced swimwear. “This isn’t fair.”