Analysis: China is facing its “Sputnik moment” because US export restrictions are hurting its plans to make chips. 

Shanghai: Experts say that China will have its “Sputnik moment” because the U.S. won’t let it export chip equipment to China. This will force Chinese chipmakers to try creative engineering solutions and go their own way, even if it might not be good for business in the long run.

The Biden administration announced sweeping new rules on October 7 that say U.S. companies can’t sell Chinese chipmakers equipment that can be used to make relatively advanced ships unless they first get a licence.

The measures will make it harder for China to build up its own chip industry and become less reliant on chips made elsewhere. China buys more than three quarters of the $556 billion worth of semiconductors that will be sold worldwide in 2021, but it only makes about 15% of the world’s output.

“The tech decoupling could be China’s Sputnik moment in innovation, forcing it to take a top-down and self-reliant approach, especially in semiconductors,” Citi economists said in a note, comparing it to the rise in spending and research in the US after the Soviet Union launched the world’s first satellite.

The restrictions also come right before the Communist Party Congress in Beijing, where President Xi Jinping is likely to get a third term, which has never happened before.

Self-sufficiency in technology is important to Xi and has been for the past ten years. It is likely that this will be a major theme at this year’s Congress.

In 2021, Boston Consulting Group said that a country would have to invest at least $1 trillion more than it did in 2021 to build “self-sufficient” local chip supply chains.

Experts say that the new restrictions are likely to make Chinese chipmakers try to make more advanced chips by coming up with creative ways to use older technologies that are not affected by the restrictions.

This is something that Semiconductor Manufacturing International Corp. (SMIC), the largest contract chip maker in China, has tried before.

Late in 2020, Washington stopped it from getting an EUV machine from the Dutch company ASML, which is a very important tool for making chips with 7 nanometer process nodes.

Sanctions are meant to stop SMIC from making more advanced chips, but some analysts have found signs that SMIC has made 7 nm chips by making small changes to simpler DUV machines that it could still buy from ASML.

Experts say, however, that such attempts are unlikely to lead to products that can be sold and made in large quantities.

“Some tools can be changed. People have ideas. But how much will it bring in? How can they sell enough to make money? “This is what you need to know,” says Marco Mezger, a consultant in Taiwan who keeps an eye on the memory chip market around the world.

Experts say that China’s equipment makers are still four to five years behind their counterparts in other countries. This means that they can’t be used right away to replace equipment lost from U.S. suppliers like KLA Corp., Applied Materials (NASDAQ:AMAT), and Lam Research (NASDAQ:LRCX).

Yangtze Memory Technologies Co. Ltd. (YMTC), which makes NAND memory chips, and Changxin Memory Technologies Inc., which makes DRAM chips, are also likely to take a hit (CXMT).

Both YMTC and CXMT are state-backed companies that started up about 10 years ago. They are China’s best chance to break into the global market, competing with top players like Samsung Electronics (OTC:SSNLF) and Micron Technology (NASDAQ:MU).

But neither company has mass-produced cutting-edge technology yet, even though they have made progress. For example, YMTC says it has developed 232-layer NAND, and CXMT is said to be getting closer to mass-producing 10nm DRAM.

When asked for comments, SMIC, YMTC, and CXMT did not answer.

Winter is on its way.

China’s efforts to grow its own chip industry have been good for many toolmakers outside of China, so their bottom lines will also take a hit.

Each of KLA, Applied Materials, and Lam Research gets about 30% of their sales from China, which is their biggest market and the one that is growing the fastest.

Applied Materials said on Wednesday that export restrictions to China would cause net sales to drop by $250 million to $550 million in the quarter that ends on October 30. The same thing is expected to happen in the three months after that.

One source at an equipment company told Reuters, “Until we see some $10 billion fab set up in Ohio or Oregon, I have a lot of worries about our revenue next year.” This person was referring to the CHIPS Act, which gives $52.7 billion in subsidies to U.S. chip production and research.

Sources at companies that make tools also said that they are scrambling to meet the new export restrictions. Some companies have ordered a broad supply ban to make sure they don’t break the rules, which they say aren’t clear.

“If we follow the bill to the letter, the companies that make the equipment might have to shut down,” said a seller of chip equipment who asked not to be named because the issue is sensitive.

People who know about the situation say that Washington is also scrambling to deal with the unintended effects of its new export restrictions.

South Korean company SK Hynix said that it got permission from the U.S. to get goods for its chip production facilities in China without getting the extra licences that the new rules require. This was just hours before the new rule went into effect.

But business at companies that make tools for Chinese customers has already slowed down a lot, leaving their workers with little to do and opening the door for Chinese companies that want to catch up with their Western rivals.

“Our top management has told us to take it easy for a few months. We can still come to work, but we don’t have to,” said a source at a China-based overseas equipment company.