Taiwan’s economy: Defying the odds with the AI story

Taiwan’s economy grew 8% YoY in Q2 2025, marking the fastest pace in four years. With the latest Nvidia’s financial results and earnings guidance, which still show strong demand even if it may not be as strong as market expectation. Taiwan has further solidified its position as a main winner of the AI boom. Hence, we have upgraded Taiwan’s GDP growth forecast for 2025 to 5.2%, up from 2.8% previously.Front-loading and AI demandThe momentum is driven by external demand from semiconductors related to AI. The bulk of the chips go to the US, which is now Taiwan’s largest export destination with a 33% share as of July 2025, up from 15% in 2021. Several Taiwanese firms have benefited from AI-driven demand. TSMC now derives a larger share of its revenue from high-performance computing (HPC), which is essential for AI and cloud computing. Hon Hai Precision Industry, the parent company of Foxconn, also sees its revenue from cloud and networking products surpassing consumer electronics.Growing divergence across sectorsHowever, the positive momentum does not come without risks. While the semiconductor industry has been performing well, the divergence with other sectors is growing. The key question is whether export-driven growth can be transformed into consumption. In other words, whether the profits of the high-end semiconductor industry can feed the rest of the economy, especially the service sector.Exchange rate appreciation and competitivenessIn addition, the abrupt appreciation of the Taiwan dollar back in May, which was not followed by other competitors, has made it even harder for Taiwan’s exporters in traditional industries or mature chips to compete. The 20% temporary import US tariffs on Taiwan’s exports is also higher than South Korea and Japan.Therefore, we analyze the potential impact on Taiwan with the Product Complexity Index (PCI). The higher the value, the more difficult it will be for other competitors to substitute Taiwanese exports. The good news is that Taiwan’s PCI is very high, at 0.92 in 2024, rising from 0.8 in 2018. The value is higher than 0.59 and 0.55 for South Korea and Japan, showing it is more difficult to replace Taiwan’s exports.The reasons are clear from the sector perspective. Semiconductors and ICT products tend to be more complex, and these products form 65% of Taiwan’s total exports, lifting the PCI. The two sectors have benefited from strong US demand, which can be a double-edged sword as Trump removes the current tariff exceptions. Now, the 100% tariff rate is exempt for firms who have invested in the US. Still, Taiwan’s strong competitiveness means the US would struggle to find alternative suppliers.While Taiwan’s tech sector is somewhat protected by its comparative advantage, this is not true for traditional sectors. Electrical and general machinery, which account for 8% of total exports, face more risks due to Taiwan’s relatively lower PCI compared to peers and significant US market exposure. Transport sector (notably auto parts) and chemicals may also suffer, but the channels are different. Their direct export share to the US is low, but they have a higher share of export orders from the US.Competition from red supply chainLastly, Taiwan will also face competition from the “red supply chain”. To achieve self-sufficiency, China has been actively using industrial and supply-side policies to support domestic firms. While China’s market share in semiconductors has risen from a low base, its rapid expansion in mature nodes and threaten the prospects of competitors through supply and prices. This trend means Taiwan’s tech sector will encounter challenges even if maintains leadership in advanced semiconductors.An upgrade of growth forecast in 2025, but with deceleration in 2026Considering the combination of factors, we remain cautiously optimistic about Taiwan’s outlook, but this is mostly true for a single sector of advanced chips serving the AI revolution. However, the uneven economic growth across sectors makes traditional sectors vulnerable to the relatively strong currency and US high tariffs. The AI-related sectors also run the risk of a slower than expected deployment of AI. It goes without saying that China’s growing self-sufficiency (red supply chain) could also gradually erode profit margins for Taiwanese firms., butAll in all, we expect 2025 to be a very good year for Taiwan’s GDP growth at 5.2% given the amazing first half, but risks are piling up so that the deceleration will be faster in 2026 towards 2.5%.