Taiwan is increasingly preparing for a potential attack from China, conducting extensive civil defense and military drills across the island. These exercises, held last month, involved realistic scenarios such as evacuations, simulated medical emergencies, and mock missile attacks. Despite these preparations, a majority of the Taiwanese population, around 65% according to a May survey by the Institute for National Defense and Strategic Research (INDSR), believes a Chinese invasion is unlikely in the next five years.

These efforts come as the United States emphasizes that the threat is imminent and that Beijing is readying its military to be capable of invading by 2027. President William Lai is aiming to bolster Taiwan's defenses, planning to increase defense spending by 23% next year to NT$949.5 billion (approximately $31 billion USD), representing over 3% of GDP. Military reforms include extending the mandatory military service period, increasing soldiers' pay and benefits, and implementing more rigorous training. The annual 'Han Kuang' war games are also being modernized to include realistic simulations of urban warfare scenarios, with 22,000 reservists participating.

While these drills aim to enhance readiness, they have also sparked controversy over whether they further provoke China. Some point out that the Chinese threat has always been present, and the focus on preparation might be unnecessary. Others, influenced by events like the war in Ukraine, believe preparation is crucial. Taiwan faces a challenge in convincing its citizens of the necessity of preparedness, as many believe economic ties and cross-strait connections make an invasion improbable. Nevertheless, China's growing military expansion and increasing geopolitical tensions are heightening the possibility of confrontation.

Market Signals

Increasing impact on the aerospace and defense sector due to Taiwan's heightened defense spending.
Potential volatility in tech markets as focus shifts to Taiwan's semiconductor capabilities amidst tensions.
Shifting competitor positioning in the tech and defense sectors as geopolitical risks are assessed.

Benefiting Companies: Defense industry, cybersecurity firms, and technology companies offering dual-use solutions. Affected Companies: Businesses heavily reliant on stability in the Taiwan Strait, and global supply chains that could be impacted by any disruption.

Action Timeline

Immediate: Monitoring Chinese reactions to Taiwanese drills and heightened defense preparations.
Short-term: Assessing the impact of increased defense spending on Taiwan's budget and relevant sectors.
Long-term: Tracking developments in Chinese military capabilities, international community responses, and their implications for regional stability.

Risk Assessment

Regulatory risks related to defense policies and investments.
Market volatility factors associated with geopolitical tensions.
Escalating geopolitical tensions between China, Taiwan, and the US.