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Executive Summary
Semiconductor Report - Third Quarter, 2004
October 1, 2004

Most semiconductor companies in Taiwan posted their strongest quarters in years during the past three months, and the full year 2004 will be the best since the Internet boom in 2000 sent industry sales rocketing. However, high crude oil prices, rising costs for raw materials like paper, glass, and steel, and other global factors have caused the semiconductor sector to miss a beat. Inventories have hit a multi-year high, and consumers are not buying new electronic toys fast enough to keep the industry humming. Now observers say the fourth quarter will be weaker than the third, and there may not be a rebound until the second quarter next year.

Over the long term, rising tensions in the Taiwan Strait have the potential to overshadow economics as the main threat to Taiwan's semiconductor industry. A year of elections in Taiwan has complicated the China-Taiwan relationship, particularly as Taiwan President Chen Shui-bian won the presidential race in March partially through promises for a new constitution by 2006, which China views as a tool for pro-independence forces to legally enshrine Taiwan independence. China has reiterated its threat to attack Taiwan if it moves toward independence and has even said it could attack if the island continues on a path to a new constitution. Unless current trends change, war could potentially break out between the two within the next four years, and since the global electronics industry depends on the Taiwan-China relationship for the majority of its personal computers, laptops, electronic game machines parts, and a variety of semiconductors, a conflict would shut down the entire industry.

China also gained the ability to upgrade its military technology in coming years during the third quarter. Its top chipmaker, Semiconductor Manufacturing International Corporation (SMIC) began manufacturing integrated circuits on 12-inch silicon wafers in one of the world's most advanced production facilities. The firm proved skeptics wrong; it was actually able to procure advanced manufacturing equipment that has been barred from China for years due to its possible use in military applications.

Next year, SMIC will combine the larger wafers with the latest etching process technology - 90-nanometer (0.09-micron) - putting it on par with U.S. manufacturers in terms of technology. The company has leapfrogged hurdles through technology partnerships and industry connections in a short three years, becoming a technology contender in an industry that pays top dollar for the best manufacturing processes because they take years of development to perfect.

This is not a good sign for Taiwan or its chipmakers, as China has been eroding the island's main defense - its semiconductor output. SMIC's success also shows how fast Chinese companies can compete in the foundry business, which was after all invented in Taiwan.

This report will focus on the slowing economy and its likely impact on Taiwan's chipmakers. It will also highlight the greater danger of conflict between Taiwan and China, and it will attempt to predict how Taiwan politics ahead of the December 11 Legislative Yuan elections might affect the semiconductor industry and investment in China for the rest of the year. In addition, the report will include a detailed discussion of how SMIC's ability to gain 12-inch fab equipment creates greater danger for Taiwan both for economic and national security reasons. Finally, this report will discuss the new tax rebate China is offering to stimulate its semiconductor industry - just after it said it would phase out a similar tax.

Table of Contents
Letter from the President 1
About the US-Taiwan Business Council 3
Semiconductor Analysis 5
Introduction 5
State of the Industry 6
Rising Cross-Strait Tensions Raise Risk for the Semiconductor Industry 8
China's SMIC at 90-Nanometer: Cutting Edge Technology through Partnerships 9
SMIC: Its Short, Quick Rise 12
China Replacing 17% VAT with New Chip Tax? 14
Looking Forward 15
Conclusion 15
Glossary of Terms 17
Taiwan Semiconductor Industry/Government Contact Information 27
United States Semiconductor Industry/Government Contact Information 37
Sources for Taiwan Semiconductor Industry Information 47
Semiconductor Headlines: Third Quarter, 2004 49
Appendix: Trends in Trade and Investment 57

This report is available to our members starting October 27, 2004. To purchase a copy of this report (US$50 for non-members), use this order form.

If you have any questions about the report, please contact Judson Payne, the Council's Director of Corporate Affairs. You can also call us at (703) 465-2930, or email us at Council@us-taiwan.org.

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