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Taiwan is a major flashpoint in US-China relations.

Sam Yeh/AFP/Getty Images

China’s recent sanctions against

Boeing

and

Raytheon Technologies

leaders in response to arms sales to Taiwan are probably just the beginning.

Tensions between the United States and China are on a dangerous path, but investors in multinational stocks may not feel the hit as much as those invested in Taiwanese stocks.

Taiwan, the self-governing island that China claims as its own, is a major flashpoint in an already soured relationship between the United States and China. Visits by House Speaker Nancy Pelosi and other members of Congress in recent weeks have worsened the situation. President Joe Biden’s statement in a television interview that the United States would defend Taiwan in the event of an invasion by China has again raised questions about whether the United States is moving away from its ambiguous policy towards China’s claims to the island. The White House has continued to say its one-China policy – which maintains Taiwan is part of China – has not changed.

But the comments highlight the difficult situation around Taiwan as China has stepped up live-fire military exercises around the island. Adding to the tensions: A US Senate panel has approved the Taiwan Policy Act, which includes a four-year, $4.5 billion arms deal as well as other measures that could signal a shift in policy towards Taiwan. The move drew bipartisan support and pushback from the White House.

The United States has already sold weapons to Taiwan, but the new part is that the United States could finance the weapons. Even more incendiary from Beijing’s perspective is the language that describes Taiwan as a major non-NATO ally. Symbolic steps, including changing the name of the office of the representative in the United States and appointing the representative in Taiwan to a post confirmed by the Senate, are steps that Neil Thomas of the Eurasia Group says indicate that Taiwan could be more treated as a sovereign country, which is a red sign. line for Beijing.

“Despite Biden’s comments, the administration is trying to be disciplined not to change the formal structure of the US One China policy to avoid an escalation with Beijing in the Taiwan Strait,” says Thomas, who adds that the Communist Party indicated that China did not. want to invade Taiwan in the next few years nor have the real capacity to do so. Rather, the party is focused on Taiwan not declaring independence – and the United States recognizing it as such.

For investors, the escalation on Taiwan will be a constant potential driver of volatility. But the impact on global investors in multinationals or Chinese stocks could be more muted as China’s retaliation is likely to remain symbolic, in part because it is mired in economic malaise over its zero-Covid policy and of a real estate slump.

While Beijing may continue to retaliate with sanctions against American individuals, Rory Green, head of China and Asia research at TS Lombard, sees them as intended for a domestic audience. “Beijing appears to be struggling to find appropriate retaliatory measures that inflict suffering on the entities involved without causing political and economic damage to China. Central leadership could of course escalate into tariffs and more aggressive actions against American companies, but given the state of the economy, they are unlikely to go that route,” Green said.

For now, he expects more military maneuvers, including China crossing the so-called middle line into Taiwan’s airspace in response to US arms sales and Biden’s comments on Taiwan.

Although it is unlikely to hit global multinational stocks just yet, companies are starting to face risks around China.

“Just the fact that the government is doing things like updating Taiwan law is why companies need to have contingency plans in place,” says Keith Krach, former undersecretary of state for the Trump administration and chief executive of the electronic signature company.

DocuSign
.

Krach, who is now president of the Krach Institute for Tech Diplomacy at Purdue University, said leaders “have discussions in boardrooms and see if they’re exposed. The level of risk has almost reached the level of a cybersecurity breach – for this you have a plan.

The short-term hit will be felt in Taiwanese markets, home to companies like

Semiconductor manufacturing in Taiwan

(TSM). Shares of

Taiwan semiconductor
,

a preferred investment for many long-term investors, is down 34% since the start of the year, while the


iShares MSCI Taiwan

the exchange-traded fund (EWT) is down 28% year-to-date.

But TS Lombard’s Green sees more pain ahead for the next six months, with Taiwan’s economy and stocks likely to disappoint. Not only are the factors that have driven Taiwan’s economic and stock market outperformance since 2020 — such as global demand for goods, chip shortages and Chinese economic growth — turning negative, but a greater penalty for geopolitics has yet to be reflected in Taiwanese stocks, he adds.

Write to Reshma Kapadia at [email protected]