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Can China’s fledgling semiconductor industry rescue Huawei from tighter US tech sanctions?

Huawei has stockpiled enough 5G base station chips to last until the first half of 2021.

Image credit to Visual China.

It boasts some of the highest scores for math and science students, produces brilliant scholars in fields such as quantum computing and AI, and will soon launch a probe destined for Mars. Yet China remains well behind in semiconductors, the enabling technology behind many of these achievements.

Despite recent moves to achieve greater self-sufficiency in strategic areas of technology, semiconductor design and production remains a complex business, requiring decades of research and development to advance. Meanwhile, the US just turned up the heat.

Last month Washington expanded its sanctions against Huawei Technologies by requiring foreign chip makers that use US technology to apply for a license to sell chips to the Chinese telecoms champion. That vastly expanded Washington’s reach by bringing the world’s biggest contract chip maker and key Huawei supplier Taiwan Semiconductor Manufacturing Co (TSMC) under its remit.

With the US effectively shutting the door on foreign chip suppliers that employ US technology to design or produce semiconductors for Huawei, can domestic Chinese firms step in and meet its needs?

“Huawei has no domestic substitutes for chip-making in the short term,” said a Shanghai-based economist and an industry observer, requesting anonymity due to the sensitive nature of the discussion. “It would take not only money but require joint efforts of generations of engineers and scientists slogging away at basic scientific research to make progress in the semiconductor sector.”

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Analysts said Huawei’s immediate priority is to make the most of a 120-day grace period until September to stock up on “strategic inventory,” a similar strategy to the one it used after first being put on Washington’s trade blacklist in May 2019.

Eric Tseng, CEO at Taiwan-based semiconductor research firm Isaiah Capital & Research, said there were signs that Huawei had stockpiled enough 5G base station chips to last until the first half of 2021. Meanwhile, he said Huawei’s short- to medium-term plan was to switch from TSMC to Shanghai-based Semiconductor Manufacturing International Corp (SMIC) for its low-end chips. “Regarding high-end smartphone chips and 5G chips, domestic substitutes are unlikely to provide any meaningful help before the year 2023,” Tseng said.

Established in 2000 and now the country’s largest chip maker, SMIC is currently the best Chinese alternative for Huawei and forms part of a broader push for self-reliance, receiving government support amid rising trade tensions with the US.

Hong Kong-listed SMIC announced a plan last month to raise USD 2.8 billion via a secondary offering on the Shanghai Stock Exchange to fund projects and replenish operating capital after a USD 2.2 billion investment from Chinese state-backed investors.

However, SMIC warned potential investors in the prospectus that it could not use imported US technology and equipment to make chips for “several customers” without a license from the US. SMIC also said it maintains clear and open communication lines with the US government and industry partners. “The company is always committed to compliance requirements,” it said, without elaborating.

Unisoc, a chip design unit of the Tsinghua Unigroup, is another potential domestic supplier, but it mainly targets devices for low-end products and could not support Huawei’s advanced smartphones, according to another analyst.

“For now, Huawei has no choice but to accelerate work on its own chips and to redesign numerous products,” said Forrester analyst Thomas Husson. “There are very few alternatives to its key supplier TSMC, and Huawei is likely to rely increasingly on new Chinese partners such as SMIC or Unisoc.”

Read this: The US ban on Huawei will cripple the global semiconductor industry

While SMIC is the most advanced chip maker in China right now, its 14-nanometer capability still significantly trails behind the world’s leading foundries such as TSMC, which is producing 7nm chips in volumes and recently announced its 3nm process was scheduled for trial production in the first half of next year, with mass production expected in the second half of 2022.

Huawei has been using the 7nm process at TSMC to pack 6.9 billion transistors on its Kirin 980 smartphone chip, delivering 20% improved performance and 40% greater power efficiency than the previous generation, according to Richard Yu Chengdong, the chief executive of Huawei’s consumer business group.

Hedging its bets outside China, Huawei has also been in talks with Samsung Electronics, the world’s biggest memory chip supplier and also a rival to TSMC in the foundry business, according to a Bloomberg report last month, citing the Korea Economic Daily. While Samsung also operates fabs with US equipment, it has cooperated with equipment suppliers from Europe and Japan to build a small 7nm production line, according to media reports. That would, in theory, enable it to serve Huawei without contravening the latest US export ruling.

One critical aspect of the semiconductor manufacturing process is not controlled by US companies. The market for lithography machines used to print chip designs onto wafers is dominated by Europe-based ASML, which has more than 60% market share, while Japanese suppliers Canon and Nikon account for most of the rest. However, in the advanced extreme ultraviolet (EUV) segment, ASML is the only viable player and is the sole EUV supplier to Samsung, TSMC, and Intel—the only chip makers pushing the leading edge right now.

Under pressure from Washington, the Dutch government last year blocked ASML from shipping an EUV scanner to SMIC. Without access to the state of the art in lithography, the Chinese foundry will never be able to catch up to TSMC.

Even if Huawei can get around the equipment restrictions, it faces another challenge in the design phase, where its HiSilicon chip unit relies on electronic design automation (EDA) software from US suppliers such as Cadence and Synopsys.

“It will be hard to find domestic replacements for EDA for HiSilicon in the short-term,” said Chai Jie, manager of Chengdu-based Ultra Pure Applied Materials, which is a supplier to TSMC.

Huawei declined to make any of its HiSilicon executives available for interviews and had no comment for this story.

Read this: Chinese telecoms giant ZTE clarifies that it only designs chips, does not make them, after share price spikes

The renewed restrictions on Huawei are likely to be a boon for its crosstown rival ZTE Corp, especially for future 5G orders, according to the Shanghai-based economist. “Most of [Huawei’s] domestic orders could be transferred to ZTE,” he said.

Although the current US tech sanctions are specific to Huawei, Beijing is concerned that they may be extended to other Chinese companies or sectors, especially if the tech war with the US worsens. ZTE was subject to a similar US tech ban in 2018 over a case related to US sanctions on Iran, but the order was lifted after nearly three months when the company agreed to pay additional fines to the US and make changes to its senior management.

While throwing money at China’s semiconductor problem is not a perfect solution, some experts say it could shift the dial. “Talent and people are crucial for this sector,” said Chai Jie. “One or two geniuses could make a breakthrough. That’s why state-led investment is significant for advancing this industry.”

However, doing it entirely independent of the US may be “mission impossible” based on past experience with Japan and Korea, according to some experts.

“The rise of Japanese and South Korean semiconductor industries and their high-end equipment manufacturing can largely be attributed to their ties with US industry chains, besides the investment from the state,” said Gary Yang, a founding partner at Beijing-based venture capital firm Sky Saga Capital.

“It’s like having a customer with the entire know-how of an industry. They can help guide you at some crucial junctures. That is why investment alone can’t succeed and we need crucial directional guidance along the way,” Yang said.

This article was originally published by the South China Morning Post.