Why China's Indium Phosphide Controls Are Slowing AI Data Centers

China's export controls on indium phosphide (InP) have become one of the most sensitive pressure points in the global race to build AI infrastructure. InP is a compound semiconductor with no real substitute in the high-speed optical chips that move data inside AI data centers. It is essential for lasers and photodetectors used in optical transceivers, the components that handle the bulk of communication between servers in large AI clusters. Silicon photonics, often cited as an alternative, cannot match InP performance at the shorter wavelengths that matter most for short-reach data center links, so the material remains a hard requirement rather than a preference.

Beijing placed indium phosphide under export control on February 4, 2025, the same day it tightened restrictions on indium and several other strategic materials. The stated reason was to limit the export of dual-use materials with potential military applications, and the rules require a separate export permit for every individual customer order. Because China produces around 70 percent of the world's refined indium, the upstream raw material that feeds InP wafer production, the controls gave Beijing a powerful lever over a supply chain that the AI buildout depends on.

The consequences built up gradually through 2025 and into 2026 rather than arriving as a single shock. Permits were issued slowly and unevenly. AXT, the world's second-largest InP substrate producer and a key supplier to Nvidia-backed chipmaker Coherent, manufactures most of its substrates through its Beijing subsidiary Tongmei and only received its first export permit in late June 2025. A significant order backlog formed and continued to weigh on supply. The company has described InP export permits as the single most significant challenge it faces. The slow pace of approvals directly hit AXT's results, with fourth-quarter 2025 revenue falling below guidance because fewer permits than expected were granted by China's Ministry of Commerce.

The strain spread well beyond AXT and Coherent. Analysts at SemiAnalysis noted that the restrictions ripple through the entire optical supply chain. Lumentum is reported to be sold out through 2028 even after quadrupling its output, which shows that simply adding device capacity cannot solve a problem rooted in substrate scarcity. Taiwanese optical component makers including VPEC and LandMark Optoelectronics also faced disruptions tied to AXT permit delays. The pricing signal was unmistakable, with the average price of a 6-inch InP wafer climbing roughly 250 percent to around 5,000 dollars since the controls began.

By early May 2026 the issue had reached the top of US-China diplomacy. Coherent warned of an InP shortage on an early May earnings call, and within days its chief executive Jim Anderson joined a US business delegation traveling to China with President Trump, in part to press Beijing on the export license delays. The matter was also raised during trade talks in Seoul ahead of the May 14 to 15 summit between Trump and President Xi Jinping. The fact that a niche compound semiconductor substrate became a summit-level topic underlines how central it has become to the AI infrastructure question.

There are early signs of a partial easing rather than a resolution. In mid-June 2026, reporting indicated that China had released a fresh batch of InP substrate exports, the first such 2026 batch shipping at the end of May following an earlier release in 2025. This loosened the immediate bottleneck somewhat, but the underlying permit-by-permit system remains in place and supply stays tight against booming demand.

Efforts to build supply outside China are underway but slow. Coherent said it is doubling InP wafer capacity at its Texas plant during 2026 and plans to more than double that again by the end of 2027. AXT itself is expanding capacity, aiming to double its late-2025 output by the end of 2026. Industry estimates point to lead times of 18 to 24 months for new equipment, meaning meaningful relief from non-Chinese sources is unlikely before 2027 at the earliest. For now the global AI buildout remains exposed to a material that one company largely supplies from a single country, and the situation continues to evolve as permit volumes and diplomatic talks shift month to month.