Strategy Note /

China-Taiwan impact from Russia-Ukraine

  • Is China emboldened on Taiwan by Russia's actions in Ukraine? Taiwan asset prices certainly do not reflect such risk

  • Similarities: disputed sovereignty, capital buffers, local military superiority, challenger to "Western" world view

  • Differences: Semis and Asia supply chains vitally strategic for US, Xi's domestic politics, manufactured export reliance

China-Taiwan impact from Russia-Ukraine
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
24 February 2022
Published byTellimer Research

The nightmare scenario for those who decry the erosion of an international order, governed by a "rules-based" system, is that China feels emboldened by the tepid military response, so far, with which Russian actions in Ukraine have been met, to accelerate its ambitions in Taiwan.

The credibility of a decisive, interventionist military threat from the remaining global superpower, the US, has declined following the chaotic Afghanistan withdrawal and the polarisation in domestic US politics. The Chinese have already exploited this in their territorial incursions in the South China Sea (which they would describe as reclamations).

The Russian invasion of Ukraine – which, in turn follows its 2008 Georgia war, 2014 Crimea annexation, international cyberattacks and assassinations – reinforces this sense that the US is unwilling to deploy its overwhelming military power in hot conflicts far from home.

Despite several important similarities in both situations, the differences are critical; namely, cutting-edge Semiconductor manufacturing capacity in Taiwan and broader Asia supply chains are vitally strategic for the US, and President Xi ignites a higher level of domestic political risk with anything less than a short-lived, completely successful, non-sanctions triggering incursion into Taiwan than President Putin does with the invasion of Ukraine.

In any event, from an investment perspective, it is clear that acute geopolitical disruption is priced into Russian assets compared to almost none in those of Taiwan.

Several large China aircraft sortie in Taiwan ADIZ in last year

Similarities and differences

The similarities between the China-Taiwan and Russia-Ukraine situations are the following:

  • Sovereignty of both Taiwan and Ukraine has been subject to long-running dispute.

  • Capital buffers, low gross government debt and high FX reserves can, for a while at least, insulate China and Russia from the blowback of sanctions.

  • Military superiority is overwhelmingly in favour of China and Russia in a local context, ie compared to Taiwan and Ukraine, respectively, in isolation.

  • The international order is criticised by both China and Russia, which view it as determined, in theory, by the liberal political values of the US (to which neither subscribes), but, in practice, by realpolitik priorities of the US (to which China and Russia have their own competing priorities).

The differences between the China-Taiwan and Russia-Ukraine situations are the following:

  • Chinese forces have to cross naval and airspace which it does not fully control to reach Taiwan, whereas Russia shares one land border with Ukraine, has a client state (Belarus) on another, controls the sea on another, and has separatist allies already in control of territory in Ukraine.

  • Taiwan has global strategic value – a concentration of leading-edge semiconductor manufacturing capacity, vital for all military, communication and manufacturing hardware – which Ukraine does not. TSMC has 55% global share of outsourced manufacture of semis, at least a two-year lead on 5nm production, and 80% of its capacity is in Taiwan. In crude oil terms it is equivalent combined share of reserves of all the low-cost Middle East producers (GCC, Iran, Iraq, Libya).

  • Asia's sea-based supply chain for manufactured and commodity goods has global strategic value and while Taiwan, in the event its territorial waters came under hostile control, could be circumvented the signal it sends for key choke points elsewhere (eg in waters that China already disputes near Vietnam, Philippines, and Malaysia) would be grave.

  • China and Russia both rely on exports for their economic growth and the health of their sovereign balance sheet (capital buffers). However, arguably, the US-EU-Japan could live without low-cost Chinese manufacturing exports for longer than the EU, in particular, could live without Russian fuel exports. In the longer-term, the opposite may be true — there is no single supplier of cheap manufacturing of a scale to replace China although India has the potential to do more than merely chip away at China's market share like Vietnam or Bangladesh, whereas, the EU can transition, ultimately, to alternative sources of fuel and electricity.

  • China President Xi arguably has more serious domestic political risks to contend with than Russia President Putin: the economic growth expectations of the population are higher and sanctions, which for a while China's customer countries could impose, would throttle that growth, and Xi has domestic rivals within the Communist Party which he would embolden with anything less than a short and comprehensively successful re-integration of Taiwan.

  • There is no similar, short-term catalyst (or, pretext) for China to accelerate its ambitions in Taiwan in the way that post-Cold War NATO enlargement and the desire of the Ukrainian government to push for membership did for Russia. More intense US governmental contact with the Taiwan government can alter this.

  • The pricing of risk by investors is very different in China-Taiwan, compared to Russia-Ukraine. A return to a real effective exchange rate of 100 would imply 10% downside for the Taiwan FX rate compared to 25% upside for the Russian spot FX rate. The forward price/earnings multiple of Taiwan equities (TWSE) is on a 13% discount to its 5-year median compared to a 58% discount in Russia equities (MoEx).

The changing art and risk of war

In general, the nature of wars has changed following not only the changes in US foreign policy discussed above but also changes in technology and the use of mercenaries and proxies, level some of the playing field between two militaries that are mismatched in terms of conventional strength.

The results are more competition between global and regional powers in areas where the US is choosing to reduce its commitment, greater military spend by all countries that can afford it, faster escalation of conflict, but also, critically, a shorter path to de-escalation.

That argument is worth bearing in mind, when interpreting mainstream media coverage of conflicts like Russia-Ukraine, Iran-Israel, India-Pakistan, and, potentially, one day, China-Taiwan.

For more on this, see EM Wars: The changing art and risk of war, March 2020.

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