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Executive Summary
Semiconductor Report - Second Quarter, 2004
July 1, 2004

The past three months saw a major breakthrough for Taiwan companies in their bid to gain a foothold in China, namely final permission granted by Taipei for Taiwan Semiconductor Manufacturing Co. (TSMC) to start production at its Shanghai facility by the end of the year. Judging by its role in Taiwan's development, TSMC will likely have a massive impact on the development of China's chip industry - particularly in design - due to its expertise and ability to help companies create chips that are ready for production lines.

TSMC's move to China should also prove to politicians in Taiwan that there is little need to fear a 'hollowing out' of the local semiconductor industry. Some have expressed concerns that allowing TSMC to build a factory in China would lead to an exodus of manufacturers, leaving to take advantage of lower labor costs in China, but the recent semiconductor industry boom has actually slowed company plans to build new production lines in China.

Nevertheless, the growing political rift between Beijing and Taipei does not bode well for semiconductor packaging and testing companies, since one of Taipei's main political tools against China is the threat to withhold investment, particularly in the high-tech sector that China covets most. Further delay in allowing its packagers and testers to build new factories in China could begin to take its toll, as global competitors rush there to take advantage of low cost labor, which is particularly important in the packaging sector of the industry.

The current political impasse could last until after the key Legislative Yuan (LY) elections in December, since China has set its sights on keeping Taiwan President Chen Shui-bian's ruling party from gaining control of the legislature. China has already stepped up rhetoric against key business allies of Chen's, namely tycoon Hsu Wen Lung - head of the Chi Mei Group, one of Taiwan's largest conglomerates. Since Taiwan's ability to strike back is limited, politicians may opt to further slow investment. That could mean the timeframe for a second company gaining approval for a chip plant in China could be delayed despite the process now being better defined and transparent. It's a good thing that the current global chip boom has production lines whirring so fast that companies in Taiwan have put off plans to enter China.

Business has been brisk for Taiwan semiconductor firms so far this year, and most companies are looking forward to an even stronger second half. Although there is some uncertainty among market watchers regarding the second half of the year, executives in Taiwan's chip industry appear very confident, predicting record sales for the rest of the year.

This quarterly report will focus on the state of relations between Taiwan and China and how that might impact chip investment across the Taiwan Strait. It will include a detailed discussion of how TSMC's presence in Shanghai could boost China's chip industry development, with a glimpse at the current development of China's integrated circuit (IC) design industry. The report will also highlight the recent delivery of advanced semiconductor production equipment to China's Semiconductor Manufacturing International Corp. (SMIC) - the first time 12-inch equipment has ever been set up in China - and discuss how regulations surrounding sensitive chip equipment are shaping up. Finally, in an addendum this report will analyze the elimination of China's preferential Value-Added-Tax (VAT) rebates for domestically produced semiconductors, and look at the impact this important change will have on Taiwan chipmakers and on the future of China's chip industry. In addition, the analysis portion is followed by a glossary of terms used in this report.

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
TSMC Gains Final Authorization to Invest in China 7
The Growing IC Design Industry in China 11
Taiwan Packaging and Testing Firms Need China Now 13
SMIC Takes Delivery of 12-inch Equipment 14
Semiconductor Boom Takes Wind Out of Taiwan's China Investment Plans 15
Taiwan DRAM Firms Could Make Island the Leader in 12-inch Plants 16
Conclusion 17
Addendum: Taiwan Chipmakers to Benefit from Resolution of China Semiconductor VAT Dispute 19
Glossary of Terms 21
Taiwan Semiconductor Industry/Government Contact Information 31
United States Semiconductor Industry/Government Contact Information 41
Sources for Taiwan Semiconductor Industry Information 51
Semiconductor Headlines: Second Quarter, 2004 53
Appendix: Trends in Trade and Investment 61

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