Taiwan’s warning that a delay in passing its proposed $40 billion special defense budget could create a “rupture” in its defensive line against China marks more than a domestic political dispute. It signals rising vulnerability at a time when Beijing’s military pressure is intensifying — and when Washington is hardening its stance on Taiwan contingency planning. For global markets, the message is clear: cross-strait risk is no longer theoretical.
On the same day Taiwan’s defense minister issued his starkest warning yet, the U.S. House of Representatives passed the PROTECT Taiwan Act by an overwhelming 395–2 margin, threatening to exclude China from major global financial institutions if Beijing moves against the island. These two developments — one reflecting internal fragility, the other external resolve — together define a critical inflection point for Indo-Pacific security and global market stability.
The Budget Deadlock: What’s at Stake?
President Lai Ching-te proposed the NT$1.25 trillion (approximately US$40 billion) special defense budget late last year to fund an eight-year modernization drive covering missile defenses, long-range precision weapons, unmanned systems, and asymmetric deterrence capabilities. The plan is designed to make any Chinese military operation against Taiwan prohibitively costly — a strategy that aligns closely with U.S. defense planning guidance.
But the opposition-controlled legislature has blocked the budget at least four times since its introduction, refusing even to place the bill on the agenda for substantive debate. The main opposition Kuomintang (KMT), whose vice chairman visited Beijing just last week, argues it will not sign “blank cheques” and demands full scrutiny. The smaller Taiwan People’s Party (TPP) has conditioned its support on the president first briefing lawmakers on national security strategy and U.S. arms procurement rationale.
Defense Minister Wellington Koo’s language on February 11 was unusually stark. Speaking alongside the heads of all three military branches, Koo warned: “We do not want Taiwan to become the rupture in the Indo-Pacific collective deterrence posture.” President Lai framed the stakes in terms of credibility, cautioning that Taiwan could fall off the priority list for U.S. arms deliveries if the budget remains stalled. The government had engaged in intensive consultations with Washington on weapons requirements, and the $40 billion spending plan directly enables the $11.1 billion U.S. arms sale — the largest ever for Taiwan — announced by the Trump administration in December.
This is not the first time Taiwan’s defense spending has been held hostage by legislative gridlock. In the early 2000s, then-President Chen Shui-bian’s attempt to push through a U.S. arms purchase was blocked by the KMT-controlled legislature for years, eventually scaling down dramatically. Analysts at the Atlantic Council note that the current situation may be worse: the military balance has shifted further in Beijing’s favor, and Washington is applying considerably more pressure on Taipei to invest in its own defense.
A poll conducted by the Taiwan Public Opinion Foundation in December found that a majority of Taiwanese — including roughly one-third of KMT and TPP supporters — oppose shelving the defense budget, suggesting the opposition’s stance may carry political risk.
China’s Escalating Pressure
The budget debate unfolds against a backdrop of unprecedented Chinese military activity. Taiwan’s National Security Bureau reported a record 3,764 PLA air incursions into the island’s air defense identification zone (ADIZ) in 2025, a 22% increase over 2024’s already record-breaking figures. Since President Lai’s inauguration in May 2024, average monthly incursions have exceeded 300 — more than double the prior two-year average.
The escalation has not been limited to routine probing. The PLA’s “Justice Mission-2025” exercise in late December brought 130 aircraft sorties in a single day, with 90 crossing the Taiwan Strait median line — a figure that would have been unthinkable just a few years ago. The exercise rehearsed a full maritime blockade, including simulated strikes on Taiwanese targets and, for the first time, the deployment of amphibious assault ships conducting helicopter-borne infantry drills off Taiwan’s eastern coast. The PLA fired 27 rockets into waters near Taiwan’s 24-nautical-mile line, the first live-fire exercise in the Strait since 2022.
Perhaps most significantly, China’s military is steadily eroding the de facto buffers that have preserved a fragile peace for decades. PLA and coast guard vessels have begun penetrating Taiwan’s contiguous zone — the 12-nautical-mile buffer surrounding territorial waters — with increasing regularity. What was once an unofficial but respected boundary is becoming another contested space in Beijing’s salami-slicing strategy.
On the very morning of Minister Koo’s press conference, Taiwan’s defense ministry detected 11 Chinese military aircraft — including nuclear-capable H-6K bombers — operating to the island’s east and southwest for long-distance training in the Pacific. The timing underscored Beijing’s message: military pressure will continue regardless of Taipei’s domestic politics.
The U.S. Factor: Hardening Legislative Signals
Washington’s response to the cross-strait dynamic is becoming more concrete. The PROTECT Taiwan Act, passed by the House on February 10 with near-unanimous bipartisan support, would direct the U.S. to exclude China from six major international financial organizations — including the G20, the Bank for International Settlements, the Financial Stability Board, the Basel Committee on Banking Supervision, and the International Association of Insurance Supervisors — if Chinese actions threaten Taiwan’s security, economy, or social system.
The bill’s sponsor, Republican Representative Frank Lucas, explicitly modeled it on legislation passed after Russia’s invasion of Ukraine, framing it as a deterrence signal: “If China intends to engage in conflict with Taiwan, then China should be prepared to withstand the consequences.” Democratic Representative Greg Stanton reinforced the bipartisan message, stating that governments threatening their neighbors should not continue to benefit from global systems.
The legislation must still pass the Senate and receive presidential signature, but the lopsided vote margin sends an unmistakable signal to Beijing. Combined with the record $11.1 billion arms sale and growing congressional criticism of Taiwan’s opposition for cozying up to Beijing, Washington is clearly tightening the deterrence framework — while simultaneously raising the bar for Taipei’s own commitment.
For investors, the PROTECT Taiwan Act represents a potential paradigm shift in how financial contagion from a cross-strait crisis could be managed — or weaponized. Exclusion from the G20, BIS, and Basel Committee would fundamentally alter China’s integration with the global financial architecture, with cascading implications for trade finance, capital flows, and regulatory cooperation.
Market and Economic Implications
The intersection of Taiwan’s domestic political dysfunction with escalating Chinese military pressure and hardening U.S. policy creates a risk matrix that global markets cannot ignore.
Semiconductor supply chain exposure remains the most acute vulnerability. Taiwan Semiconductor Manufacturing Company (TSMC) fabricates the vast majority of the world’s most advanced chips. Any disruption to cross-strait stability — whether from military escalation or political uncertainty around Taiwan’s defense preparedness — introduces tail risk into the global technology supply chain. The defense budget delay does not directly affect TSMC’s operations, but it feeds into broader assessments of Taiwan’s strategic resilience.
Currency and capital flow sensitivity is another channel. The Taiwan dollar and regional equity markets have historically responded to cross-strait tension spikes, and the combination of a defense budget impasse with China’s largest-ever military exercises creates a potentially volatile backdrop. Defense-related equities across the Indo-Pacific — particularly in Japan and South Korea — have been trending higher as regional rearmament accelerates.
Safe-haven dynamics bear watching. Gold, the U.S. dollar, and sovereign bond flows tend to reflect shifts in geopolitical risk perception. While cross-strait tensions have not yet triggered a sustained repricing, the convergence of budget paralysis, military escalation, and legislative signaling from Washington could shift the calculus for institutional allocators reassessing Asia-Pacific exposure.
Scenario Analysis
The trajectory of Taiwan’s defense budget dispute will send distinct signals to different audiences.
If the budget passes relatively intact, it would demonstrate political cohesion under pressure, reinforce credibility with Washington, and signal to Beijing that internal divisions will not translate into strategic vulnerability. Markets would likely interpret passage as a stabilizing development, potentially compressing the risk premium currently embedded in cross-strait scenarios.
If the deadlock persists or the budget is significantly diluted, the risks multiply. Washington may question Taiwan’s willingness to invest proportionally in its own defense, potentially complicating future arms deliveries and strategic cooperation. Beijing could interpret prolonged gridlock as evidence of fracturing resolve — a misjudgment that increases the risk of miscalculation. As one DPP legislator warned: “The longer Taipei delays, the more likely Beijing is to misjudge Taiwan’s political resolve. Deterrence depends on readiness.”
A middle path — where the TPP’s proposed modifications gain traction and produce a revised but still substantial spending package — may be the most likely outcome. The TPP’s leader recently traveled to the United States before announcing his party would propose changes, suggesting engagement rather than outright obstruction. This would partially address concerns from both Washington and Taipei’s defense establishment while preserving some legislative oversight.
Broader Indo-Pacific Security Implications
Taiwan’s defense budget debate does not exist in isolation. It is part of a broader regional rearmament trend driven by China’s expanding military footprint.
Japan has approved a record defense budget exceeding ¥9 trillion ($58 billion) for fiscal 2026, up 9.4% year-on-year and part of a five-year program to double defense spending to 2% of GDP. Prime Minister Sanae Takaichi has stated explicitly that Japan’s military could get involved if China takes action against Taiwan — a historically unprecedented declaration from Tokyo. Japan is deploying long-range missiles, establishing coastal drone defense systems, and opening a new office dedicated to countering Chinese operations in the Pacific.
The Philippines continues to deepen defense cooperation with both the United States and Japan, while South Korea, Australia, and several ASEAN nations are recalibrating their security postures in response to Beijing’s assertiveness. A failure to pass Taiwan’s defense budget would not only weaken the island’s own preparedness but could complicate the broader regional deterrence architecture — creating precisely the “rupture” that Minister Koo warned against.
For investors, policymakers, and strategic analysts, the message from this week’s developments is that cross-strait risk now operates on multiple simultaneous tracks: military escalation from Beijing, legislative hardening from Washington, and domestic political uncertainty in Taipei itself. The defense budget stalemate is a stress test for Taiwan’s democratic institutions — and for the global system’s ability to price and manage the risk of its most consequential geopolitical flashpoint.
