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Japan-South Korea rift

China caught in crossfire of Tokyo-Seoul chipmaking feud

Global semiconductor industry at risk as Japan readies next round of export controls

A chip developed by Huawei unit HiSilicon is displayed. China wants to nurture a home-grown chip industry, but it is still reliant on South Korea.   © Reuters

SEOUL/GUANGZHOU/TOKYO -- Japan's plan to impose further export restrictions on Seoul is casting a shadow over China's technology sector, which now relies heavily on South Korean companies for its semiconductor supply.

Major South Korean chipmakers Samsung Electronics and SK Hynix together are responsible for about 50% to 70% of the world's memory chip market, and they produce a sizable chunk of that in China using materials imported from Japan. But Tokyo could slam the brakes on those shipments, which could also have implications for the global chip industry.

Japan's Stella Chemifa and Morita Chemical Industries currently supply about 90% of high-grade hydrogen fluoride etching gas -- used in the process of etching circuits on chips that is an essential ingredient in semiconductor production in South Korea. The gas is one of three Japanese exports that now requires case-by-case government approval under tightened rules. Tokyo has said it implemented the new regulations over national security concerns.

Japan exported about 36,800 tons of hydrogen fluoride to South Korea last year, according to Japanese government data.

"Etching gas imported from Japan is processed in South Korea and used at chip plants of Samsung and SK Hynix," a source at South Korea's Ministry of Trade, Industry and Energy. "Some of the material is then exported to their sites in China."

The source stressed such shipments are subject to stringent controls. "When the etching gas is exported to China, we require vendors to report who the end user will be, and to sign a contract to stick to the plan," the source said.

"If the material ends up somewhere other than the indicated end user, or if we find that the vendor filed false information, we take legal action."

The shipments are still relatively straightforward because South Korea is on Japan's white list of trusted trade partners. If Japan removes the country from its list, which it is considering doing as early as the end of August, reexport procedures could become significantly more complicated.

About 4,000 tons of high-grade hydrogen fluoride was shipped from South Korea to China last year, according Chinese customs authorities. Most had originally come from Japan.

About 70% went to Shaanxi Province, where Samsung produces NAND flash memory, and about 30% to Zhejiang Province, where SK Hynix makes DRAM chips.

A quarter of Samsung's NAND chips and 40% of SK Hynix's DRAMs are made in China, according to a South Korean analyst. Tougher restrictions of hydrogen fluoride to China could deal a heavy blow to the companies' chipmaking operations there, which in turn would squeeze local clients.

"Huawei Technologies are among those expected to feel a deep impact," a Chinese securities analyst said, adding that computer and server makers could also feel the heat.

Chinese players likely will be unable to fill the shortage caused by any disruption to Samsung and SK Hynix's supply. China aims to produce 40% of the chips used there domestically by next year as part of President Xi Jinping's "Made in China 2025" initiative. The current figure is believed to be just above 10%.

"More advanced chips are harder to make, and it will take years before we have homegrown ones," a Chinese industry insider said. That American, Japanese and Dutch companies dominate the market for complex chipmaking equipment is another roadblock as well.

In the meantime, South Korean players are trying -- and struggling -- to find alternative sources for hydrogen fluoride. For example, major producer Showa Denko only makes the material in Japan.

"The fact that South Korean chipmakers are dead-set on using Japan-made products, even in China, shows the difficulty of finding alternatives of a similar quality," a Japanese securities analyst said. One possibility is for Japanese suppliers to ship the chemical straight to China.

A 30% shortage in chipmaking materials would shave 2.2 percentage points off South Korea's gross domestic product and 0.04 point off Japan's, the Korea Institute for International Economic Policy estimates. Retaliatory measures by South Korea would widen the impact to 3.1 and 1.8 points, respectively, it said.

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