Johanna Chua

Ronit Ghose, CFA

Jamshed Dadabhoy

Surendra Goyal

Rishi V Iyer

Samiran Chakraborty

Anurag Jha

Venkatesh Balasubramaniam

Raashi Chopra

Saurabh Handa

Vijit Jain

Gaurav Malhotra

Aditya Mathur

Arvind Sharma

Atul Tiwari

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David Lubin

Edward L Morse

Tracy Xian Liao

Michel Nies

David Cowan

Wei Zheng Kit

Piotr Kalisz

Ernesto Revilla

Ivan Tchakarov

Artem Zaigrin

The second is the increasingly loud accusation from recipient countries that the initiative is too little ‘win-win’ and too much ‘China-win’. This summer the Malaysian prime minister Mahathir Mohamad described a “new colonialism” — a phrase that captures the idea that the BRI has led to the accumulation of liabilities on receiving countries’ balance sheets to pay for projects of uncertain value, built mostly by Chinese contractors on opaque terms, allowing China’s regional influence to grow in ways that are out of proportion to the benefits that countries can expect to enjoy. This kind of concern led to Malaysia’s suspension last month of the $20 billion East Coast Rail Link, one of the biggest-ticket projects in the entire BRI. Even Pakistan, whose people and governments routinely express the world’s most amiable view of China, recently cut down the scale and cost of the Karachi-Peshawar railroad project. The IMF’s Managing Director has called for ‘absolute transparency’ in the nature of the liabilities the BRI is creating. A third source of unease now facing the BRI is the explicit opposition of the United States, made clear in recent speeches by the U.S. Vice President, who has warned recipient countries against what he described as a ‘constricting belt’ and a ‘one-way road’. What started off as an unwelcoming but tolerant U.S. response to the BRI five years ago has now turned into outright hostility. The BRI should be understood as in the context of a shift in Chinese foreign policy that has become evident in the past few years. The Deng-era concept of tao guang yang hui — ‘hide your light and make the most of your obscurity’ — was replaced in late 2013, shortly after Xi’s Kazakhstan speech, with a more assertive principle: fen fa you wei, or ‘exert yourself and get things done’. The BRI can be seen as an extension of this principle into the economic sphere. As with any new foreign policy strategy, a period of reassessment will follow the initial implementation. In broad terms, Chinese scholars are already debating whether China has been guilty of ‘strategic overstretch’ in recent years. Given some of the constraints that the BRI has faced since its launch, the question can similarly be posed about the initiative itself. Perhaps what will emerge from this debate is a ‘kinder, gentler’ BRI, one that is more sensitive to the international criticisms described above, and one that more obviously meets China’s objective of becoming a ‘many-to-many’ platform for international cooperation that links countries through the development of infrastructure, trade agreements, a simplification of customs procedures, and cultural exchange. One indication that this might be the case lies in China’s growing interest in co-financing BRI projects with multilateral developments banks. Since these banks require open tendering and adherence to strict governance standards, their involvement could create a more multilateral-looking BRI. Though it might change shape, the BRI is certainly not going away. This report aims to set out its contours and to provide an assessment of where the initiative stands, what the economic effects have been, and some of the policy issues that have been raised by China’s remarkable foray into international economic leadership. Authors: David Lubin,Johanna Chua,Piotr Kalisz,Edward L Morse,Ernesto Revilla,Wei Zheng Kit,David Cowan,Tracy Xian Liao,Michel Nies,Ivan Tchakarov,Artem Zaigrin,Authors: David Lubin,Johanna Chua,David Cowan,Piotr Kalisz,Tracy Xian Liao,Edward L Morse,Michel Nies,Ernesto Revilla,Ivan Tchakarov,Wei Zheng Kit,Artem Zaigrin,Authors: David Lubin,Johanna Chua,David Cowan,Piotr Kalisz,Tracy Xian Liao,Edward L Morse,Michel Nies,Ernesto Revilla,Ivan Tchakarov,Wei Zheng Kit,Artem Zaigrin,Authors: Authors: David Lubin,Johanna Chua,David Cowan,Piotr Kalisz,Tracy Xian Liao,Edward L Morse,Michel Nies,Ernesto Revilla,Ivan Tchakarov,Wei Zheng Kit,Artem Zaigrin,Authors: David Lubin,Johanna Chua,David Cowan,Piotr Kalisz,Tracy Xian Liao,Edward L Morse,Michel Nies,Ernesto Revilla,Ivan Tchakarov,Wei Zheng Kit,Artem Zaigrin,Authors: David Lubin,Johanna Chua,David Cowan,Piotr Kalisz,Tracy Xian Liao,Edward L Morse,Michel Nies,Ernesto Revilla,Ivan Tchakarov,Wei Zheng Kit,Artem Zaigrin,

The second is the increasingly loud accusation from recipient countries that the initiative is too little &lsquo;win-win&rsquo; and too much &lsquo;China-win&rsquo;. This summer the Malaysian prime minister Mahathir Mohamad described a &ldquo;new colonialism&rdquo; &mdash; a phrase that captures the idea that the BRI has led to the accumulation of liabilities on receiving countries&rsquo; balance sheets to pay for projects of uncertain value, built mostly by Chinese contractors on opaque terms, allowing China&rsquo;s regional influence to grow in ways that are out of proportion to the benefits that countries can expect to enjoy. This kind of concern led to Malaysia&rsquo;s suspension last month of the $20 billion East Coast Rail Link, one of the biggest-ticket projects in the entire BRI. Even Pakistan, whose people and governments routinely express the world&rsquo;s most amiable view of China, recently cut down the scale and cost of the Karachi-Peshawar railroad project. The IMF&rsquo;s Managing Director has called for &lsquo;absolute transparency&rsquo; in the nature of the liabilities the BRI is creating. A third source of unease now facing the BRI is the explicit opposition of the United States, made clear in recent speeches by the U.S. Vice President, who has warned recipient countries against what he described as a &lsquo;constricting belt&rsquo; and a &lsquo;one-way road&rsquo;. What started off as an unwelcoming but tolerant U.S. response to the BRI five years ago has now turned into outright hostility. The BRI should be understood as in the context of a shift in Chinese foreign policy that has become evident in the past few years. The Deng-era concept of tao guang yang hui &mdash; &lsquo;hide your light and make the most of your obscurity&rsquo; &mdash; was replaced in late 2013, shortly after Xi&rsquo;s Kazakhstan speech, with a more assertive principle: fen fa you wei, or &lsquo;exert yourself and get things done&rsquo;. The BRI can be seen as an extension of this principle into the economic sphere. As with any new foreign policy strategy, a period of reassessment will follow the initial implementation. In broad terms, Chinese scholars are already debating whether China has been guilty of &lsquo;strategic overstretch&rsquo; in recent years. Given some of the constraints that the BRI has faced since its launch, the question can similarly be posed about the initiative itself. Perhaps what will emerge from this debate is a &lsquo;kinder, gentler&rsquo; BRI, one that is more sensitive to the international criticisms described above, and one that more obviously meets China&rsquo;s objective of becoming a &lsquo;many-to-many&rsquo; platform for international cooperation that links countries through the development of infrastructure, trade agreements, a simplification of customs procedures, and cultural exchange. One indication that this might be the case lies in China&rsquo;s growing interest in co-financing BRI projects with multilateral developments banks. Since these banks require open tendering and adherence to strict governance standards, their involvement could create a more multilateral-looking BRI. Though it might change shape, the BRI is certainly not going away. This report aims to set out its contours and to provide an assessment of where the initiative stands, what the economic effects have been, and some of the policy issues that have been raised by China&rsquo;s remarkable foray into international economic leadership. Authors: David Lubin,Johanna Chua,Piotr Kalisz,Edward L Morse,Ernesto Revilla,Wei Zheng Kit,David Cowan,Tracy Xian Liao,Michel Nies,Ivan Tchakarov,Artem Zaigrin,Authors: David Lubin,Johanna Chua,David Cowan,Piotr Kalisz,Tracy Xian Liao,Edward L Morse,Michel Nies,Ernesto Revilla,Ivan Tchakarov,Wei Zheng Kit,Artem Zaigrin,Authors: David Lubin,Johanna Chua,David Cowan,Piotr Kalisz,Tracy Xian Liao,Edward L Morse,Michel Nies,Ernesto Revilla,Ivan Tchakarov,Wei Zheng Kit,Artem Zaigrin,Authors: Authors: David Lubin,Johanna Chua,David Cowan,Piotr Kalisz,Tracy Xian Liao,Edward L Morse,Michel Nies,Ernesto Revilla,Ivan Tchakarov,Wei Zheng Kit,Artem Zaigrin,Authors: David Lubin,Johanna Chua,David Cowan,Piotr Kalisz,Tracy Xian Liao,Edward L Morse,Michel Nies,Ernesto Revilla,Ivan Tchakarov,Wei Zheng Kit,Artem Zaigrin,Authors: David Lubin,Johanna Chua,David Cowan,Piotr Kalisz,Tracy Xian Liao,Edward L Morse,Michel Nies,Ernesto Revilla,Ivan Tchakarov,Wei Zheng Kit,Artem Zaigrin,

A Progress Report

China’s Belt and Road Initiative (BRI) marked its fifth birthday in September 2018, though there was probably less to celebrate than the Chinese authorities might have wished. Five years after President Xi presented the initiative to the world in a speech in Kazakhstan, the BRI is facing pressures on three fronts. The first is what might be called a ‘dollar constraint’. Since the renminbi is not a fully functioning global currency, the BRI largely requires dollar-denominated financial resources to fulfill its objectives: it is significant that the major financing announcements made to kick-start the BRI in 2014 — recapitalizations of the China Development Bank, China Export-Import Bank, as well as new capital for Silk Road Fund, the AIIB, and the New Development Bank — were all made in dollars. And since China lacks an infinite supply of dollars, it therefore lacks an infinite capacity to meet its goals.

China’s Belt & Road at Five

Ronit Ghose

In order to achieve investment growth in the double digits and to create employment opportunities for its swelling labor force, India will need to industrialize further target manufacturing as a share of GDP to rise to 25% by 2025 from its current level of 18%. To do this, a new potential leading sector in manufacturing must be identified based on size, productivity, employability, and exportability. Our analysis identifies chemicals (including pharmaceuticals and petrochemicals) as a promising candidate to move up the value chain, as well as food processing and textiles & apparel. In a previous Citi GPS report Infrastructure for Growth, we estimated that on average, a 1% increase in infrastructure investment associated with a 1.2% increase in GDP growth. In the case of India, we estimate that total infrastructure spend could be around $3 trillion in the next 10 years bringing the infrastructure (power, ports, roads, rails, telecom), reforms in input markets (land and labor), focus on soft infrastructure (healthcare reforms, education) and the harnessing of resources (oil & gas, coal, cement, iron & steel) would all lead to higher productivity and growth rates. Finally, exports as a productivity driver and employment creator could play a significant role in total factor productivity growth. If India can increase its export-to-GDP ratio (including service exports) to at least 20% by 2021, India’s exports could reach ~700 Billion. The result of all this growth would be higher per capita income, increasing urbanization, and a shift in consumer patterns as India moves up the ladder form a low-growth to a high-growth economy. Authors: Samiran Chakraborty,Anurag Jha,Venkatesh Balasubramaniam,Raashi Chopra, CFA,Johanna Chua,Jamshed Dadabhoy,Ronit Ghose, CFA,Surendra Goyal, CFA,Saurabh Handa,Rishi V Iyer,Vijit Jain,Gaurav Malhotra, CFA,Aditya Mathur,Arvind Sharma,Atul Tiwari,

In order to achieve investment growth in the double digits and to create employment opportunities for its swelling labor force, India will need to industrialize further target manufacturing as a share of GDP to rise to 25% by 2025 from its current level of 18%. To do this, a new potential leading sector in manufacturing must be identified based on size, productivity, employability, and exportability. Our analysis identifies chemicals (including pharmaceuticals and petrochemicals) as a promising candidate to move up the value chain, as well as food processing and textiles &amp; apparel. In a previous Citi GPS report Infrastructure for Growth, we estimated that on average, a 1% increase in infrastructure investment associated with a 1.2% increase in GDP growth. In the case of India, we estimate that total infrastructure spend could be around $3 trillion in the next 10 years bringing the infrastructure (power, ports, roads, rails, telecom), reforms in input markets (land and labor), focus on soft infrastructure (healthcare reforms, education) and the harnessing of resources (oil &amp; gas, coal, cement, iron &amp; steel) would all lead to higher productivity and growth rates. Finally, exports as a productivity driver and employment creator could play a significant role in total factor productivity growth. If India can increase its export-to-GDP ratio (including service exports) to at least 20% by 2021, India&rsquo;s exports could reach ~700 Billion. The result of all this growth would be higher per capita income, increasing urbanization, and a shift in consumer patterns as India moves up the ladder form a low-growth to a high-growth economy. Authors: Samiran Chakraborty,Anurag Jha,Venkatesh Balasubramaniam,Raashi Chopra, CFA,Johanna Chua,Jamshed Dadabhoy,Ronit Ghose, CFA,Surendra Goyal, CFA,Saurabh Handa,Rishi V Iyer,Vijit Jain,Gaurav Malhotra, CFA,Aditya Mathur,Arvind Sharma,Atul Tiwari,

Twin Pillars of Investment & Productivity

In this report, we look specifically at India and what types of pillars can be identified to drive the country’s growth over the next decade. Although the past does not guarantee future results, we thought the best place to start the journey of how India can transform itself from an emerging economy into one that grows with a sustained GDP growth rate of 8%+, is to look at the lessons learned from countries which have already succeeded in transition. We found that growth in labor productivity of over 6%, growth in investment of over 10% and growth in the overall efficiency of production (the Total Factor Productivity) to 3% were the three primary drivers of GDP growth across our sample of countries. The final piece in the growth puzzle was that poorer economies grow faster in 60% of cases, those countries with 8%+ GDP growth had per capita income of less than $10,000.

Securing India's Growth Over the Next Decade

Ebrahim Rahbari

Benjamin Nabarro

Brian Nolan

Matteo Richiardi

Luis Valenzuela Rivera

However, within-country inequality in the larger developing countries — the same economies that have enjoyed large income growth and narrowed the differences with rich countries, such as China, India, and Indonesia — has actually increased substantially in recent years. As a result, income inequality within countries now accounts for around a third of global inequality, when it was only one-fifth in 1988. The contribution of inter-country inequality has correspondingly shrunk. Of critical focus to our research, income inequality has increased substantially within many OECD countries over recent decades after a long period of decline. The extent to which income inequality in advanced economies has grown is now widely known, though the relative importance of the range of driving forces producing these trends is less clear, as is their importance to economic growth. Rising inequality is not only a concern from a fairness perspective, in itself and in terms of its impacts on social outcomes such as health, crime, and family structures; it is also now increasingly being seen as a core issue for macroeconomic performance, implicated in the economic crisis and slow recovery from it, and as representing a major threat to long-term growth and prosperity. A range of factors has been identified contributing to the rise in income inequality across OECD countries, including technological change, globalization, changes in labor market institutions, and weakening redistribution via taxes and transfers, as well as specific factors affecting the very top of the income distribution and the distribution of wealth and income arising from this. There remain substantial differences across studies as to the relative contribution of particular elements. What is more surprising, perhaps, is that the search for effective responses is still at an early stage, although recently international organizations such as the OECD and IMF have advanced some broad recommendations to tackle inequality while promoting growth. Against this background, our research program will focus on identifying the impacts of inequality on economic growth potential, social cohesion, and the political process. On the back of this, we shall collaboratively suggest a coherent set of responses that would address rising inequality in a manner that promotes inclusive growth. The Executive Summary of this report summarizes our initial findings and conclusions. Three significant points are worth stressing here. First, it appears increasingly clear to us that if the drivers of inequality are not addressed, then inequality may become an increasing drag on economic growth due to a variety of factors which we assess throughout this report and which we shall investigate further in future research. The drag reflects wasted potential and a skills mismatch within labor forces and also that more unequal societies are less successful at investing productively for the long term. Indeed, we highlight that more unequal countries now seem to be growing less robustly than more equal ones, i.e., growth may be lower and more fragile at higher levels of economic inequality. From an investment perspective, an inequality-driven economic drag could take quite different paths in different countries leading to a consequent impact on longer-term relative asset prices and exchange rates. In other words, and put bluntly, it makes good economic sense to understand and address inequality. Second, economic inequalities are everywhere, which makes addressing the underlying issues with simple policy responses very challenging. We show in this report that inequalities have grown not just between countries but between regions within countries, between generations, between industries, and between firms. In particular, demographic forces, most notably the aging population in the developed markets, are creating a new set of inter-generational inequality challenges that are likely to get worse. Globally, wealth inequality is significantly higher than income inequality. Putting an inter-generational lens on this sharpens the issue. The debate around inequality thus needs to be related to issues such as youth unemployment, social mobility, and pension funding. Third, inequality, as well as the impact of other exacerbating factors such as lower social care budgets and the reduced provision of other government-funded services, is now clearly a critical focus in the mainstream political process and in election campaigns in many countries. In aggregate, it appears that inequality is contributing markedly to declining social trust, the erosion of social cohesion, and the fragmentation of the political process. Inequality will likely be an increasing factor in election outcomes, with social media playing a growing role in shaping perceptions. A consensus urgently needs to be reached between government, the public sector, the private sector, and society at large about how to tackle the challenge of inequality in a way that promotes inclusive and necessary economic growth. At the moment, we risk political paralysis, or worse. Authors: Brian Nolan,Ebrahim Rahbari,Matteo Richiardi,Luis Valenzuela Rivera,Benjamin Nabarro,Authors: Brian Nolan,Ebrahim Rahbari,Matteo Richiardi,Luis Valenzuela Rivera,Benjamin Nabarro,Authors: Authors: Brian Nolan,Ebrahim Rahbari,Matteo Richiardi,Luis Valenzuela Rivera,Benjamin Nabarro,Authors: Brian Nolan,Ebrahim Rahbari,Matteo Richiardi,Luis Valenzuela Rivera,Benjamin Nabarro,

However, within-country inequality in the larger developing countries &mdash; the same economies that have enjoyed large income growth and narrowed the differences with rich countries, such as China, India, and Indonesia &mdash; has actually increased substantially in recent years. As a result, income inequality within countries now accounts for around a third of global inequality, when it was only one-fifth in 1988. The contribution of inter-country inequality has correspondingly shrunk. Of critical focus to our research, income inequality has increased substantially within many OECD countries over recent decades after a long period of decline. The extent to which income inequality in advanced economies has grown is now widely known, though the relative importance of the range of driving forces producing these trends is less clear, as is their importance to economic growth. Rising inequality is not only a concern from a fairness perspective, in itself and in terms of its impacts on social outcomes such as health, crime, and family structures; it is also now increasingly being seen as a core issue for macroeconomic performance, implicated in the economic crisis and slow recovery from it, and as representing a major threat to long-term growth and prosperity. A range of factors has been identified contributing to the rise in income inequality across OECD countries, including technological change, globalization, changes in labor market institutions, and weakening redistribution via taxes and transfers, as well as specific factors affecting the very top of the income distribution and the distribution of wealth and income arising from this. There remain substantial differences across studies as to the relative contribution of particular elements. What is more surprising, perhaps, is that the search for effective responses is still at an early stage, although recently international organizations such as the OECD and IMF have advanced some broad recommendations to tackle inequality while promoting growth. Against this background, our research program will focus on identifying the impacts of inequality on economic growth potential, social cohesion, and the political process. On the back of this, we shall collaboratively suggest a coherent set of responses that would address rising inequality in a manner that promotes inclusive growth. The Executive Summary of this report summarizes our initial findings and conclusions. Three significant points are worth stressing here. First, it appears increasingly clear to us that if the drivers of inequality are not addressed, then inequality may become an increasing drag on economic growth due to a variety of factors which we assess throughout this report and which we shall investigate further in future research. The drag reflects wasted potential and a skills mismatch within labor forces and also that more unequal societies are less successful at investing productively for the long term. Indeed, we highlight that more unequal countries now seem to be growing less robustly than more equal ones, i.e., growth may be lower and more fragile at higher levels of economic inequality. From an investment perspective, an inequality-driven economic drag could take quite different paths in different countries leading to a consequent impact on longer-term relative asset prices and exchange rates. In other words, and put bluntly, it makes good economic sense to understand and address inequality. Second, economic inequalities are everywhere, which makes addressing the underlying issues with simple policy responses very challenging. We show in this report that inequalities have grown not just between countries but between regions within countries, between generations, between industries, and between firms. In particular, demographic forces, most notably the aging population in the developed markets, are creating a new set of inter-generational inequality challenges that are likely to get worse. Globally, wealth inequality is significantly higher than income inequality. Putting an inter-generational lens on this sharpens the issue. The debate around inequality thus needs to be related to issues such as youth unemployment, social mobility, and pension funding. Third, inequality, as well as the impact of other exacerbating factors such as lower social care budgets and the reduced provision of other government-funded services, is now clearly a critical focus in the mainstream political process and in election campaigns in many countries. In aggregate, it appears that inequality is contributing markedly to declining social trust, the erosion of social cohesion, and the fragmentation of the political process. Inequality will likely be an increasing factor in election outcomes, with social media playing a growing role in shaping perceptions. A consensus urgently needs to be reached between government, the public sector, the private sector, and society at large about how to tackle the challenge of inequality in a way that promotes inclusive and necessary economic growth. At the moment, we risk political paralysis, or worse. Authors: Brian Nolan,Ebrahim Rahbari,Matteo Richiardi,Luis Valenzuela Rivera,Benjamin Nabarro,Authors: Brian Nolan,Ebrahim Rahbari,Matteo Richiardi,Luis Valenzuela Rivera,Benjamin Nabarro,Authors: Authors: Brian Nolan,Ebrahim Rahbari,Matteo Richiardi,Luis Valenzuela Rivera,Benjamin Nabarro,Authors: Brian Nolan,Ebrahim Rahbari,Matteo Richiardi,Luis Valenzuela Rivera,Benjamin Nabarro,

Addressing a Growing Challenge

On average, income inequality within developing economies is very high, particularly in Africa, and higher than in the industrialized world, which creates its own major development challenges. But, in aggregate, global income inequality has declined from the late 1980s, and particularly rapidly from about 2008, as developing economies have, on average, closed some of the gap with industrialized countries. Previously, at least since the early 19th century, global inequality had increased. The driving factors behind this change have included the very real impact of globalization and technology on trade and employment, and also the transition of the formerly Communist bloc in Eastern Europe. In very simple terms, globalization has been a positive force in leveling inter-country inequality over the past 30 years. At the same time, the share of the world’s population estimated to be below the World Bank’s $1.90/day extreme poverty threshold has fallen drastically, from 35% in 1990 to 11% in 2013. Despite a major expansion in world population, the number of people in extreme poverty has fallen dramatically from 1.85 billion to under 800 million.

Inequality and Prosperity in the Industrialized World

However, the amount which we spend on infrastructure has gradually been falling as a percentage of GDP, and, while there are justifications for this, the stock of infrastructure compared to global GDP has fallen. At the same time, there is an enormous social need for infrastructure investment. Over 1.5 billion people have no access to electricity; just under 1 billion still live without safe drinking water, and over 2.5 billion are without access to basic sanitation. If the UN are right, and we need to accommodate an additional 1.5 billion people in the next 20 years, most of whom will be in emerging markets, and most of them in infrastructure-heavy urban centers, then there will be an ever more pressing need for infrastructure investment. The global economy though seems mired in a period of sluggish growth. With interest rates close to zero, or in some cases negative in real terms, and the bazooka of QE already widely deployed, policymakers are running out of monetary levers to pull. This leaves us with the potential of fiscal stimulus, one aspect of which is infrastructure spending which can boost growth using both short-term demand effects, and longer-term supply effects, with the so-called multiplier effect implying that, if done correctly, the resulting GDP boost is larger than the initial investment. However, developed market governments find themselves with debt at typically 100% of GDP, and hence limited capacity to spend, and, while emerging markets are less indebted at 40%, they are reluctant to boost debt and place sovereign ratings at risk. Traditional sources of infrastructure finance such as banks find themselves constrained by regulations such as Basel III, while insurance companies are constrained by Solvency II. Two factors, however, offer an enormous opportunity for the world. Firstly, governments can borrow at historically low rates (if not for free) for incredibly long durations. Perhaps most importantly, though, and the focus of this report, is the potential offered by private sector investment. Returns on equities and bonds have in recent years been at historic lows, and Investors are crying out for yield, in particular for long-dated, stable cashflows and income streams. Infrastructure assets lend themselves perfectly to this need, with often predictable operating characteristics, and very long, multi-decade, useful lives. Moreover, the scale of the opportunity is vast — we estimate a global need for infrastructure spending of $58.6 trillion over the next 15 years. In this report we examine why now could be the time for a global infrastructure push, and where the most exciting opportunities are by region and industry. Most importantly, though, with a need for infrastructure from a social and economic perspective and with funding keen to participate, we examine why it isn’t happening, and what stakeholders, both government and financial, need to do to make it happen. We are faced with a rare opportunity to create and grow a new asset class, build a better world that is fit for the future, and create millions of jobs in the process; and who knows, we may just kick-start the global economy in the process. Authors: Authors: Jason Channell,Elizabeth Curmi, PhD.,David Lubin,Ebrahim Rahbari,

However, the amount which we spend on infrastructure has gradually been falling as a percentage of GDP, and, while there are justifications for this, the stock of infrastructure compared to global GDP has fallen. At the same time, there is an enormous social need for infrastructure investment. Over 1.5 billion people have no access to electricity; just under 1 billion still live without safe drinking water, and over 2.5 billion are without access to basic sanitation. If the UN are right, and we need to accommodate an additional 1.5 billion people in the next 20 years, most of whom will be in emerging markets, and most of them in infrastructure-heavy urban centers, then there will be an ever more pressing need for infrastructure investment. The global economy though seems mired in a period of sluggish growth. With interest rates close to zero, or in some cases negative in real terms, and the bazooka of QE already widely deployed, policymakers are running out of monetary levers to pull. This leaves us with the potential of fiscal stimulus, one aspect of which is infrastructure spending which can boost growth using both short-term demand effects, and longer-term supply effects, with the so-called multiplier effect implying that, if done correctly, the resulting GDP boost is larger than the initial investment. However, developed market governments find themselves with debt at typically 100% of GDP, and hence limited capacity to spend, and, while emerging markets are less indebted at 40%, they are reluctant to boost debt and place sovereign ratings at risk. Traditional sources of infrastructure finance such as banks find themselves constrained by regulations such as Basel III, while insurance companies are constrained by Solvency II. Two factors, however, offer an enormous opportunity for the world. Firstly, governments can borrow at historically low rates (if not for free) for incredibly long durations. Perhaps most importantly, though, and the focus of this report, is the potential offered by private sector investment. Returns on equities and bonds have in recent years been at historic lows, and Investors are crying out for yield, in particular for long-dated, stable cashflows and income streams. Infrastructure assets lend themselves perfectly to this need, with often predictable operating characteristics, and very long, multi-decade, useful lives. Moreover, the scale of the opportunity is vast &mdash; we estimate a global need for infrastructure spending of $58.6 trillion over the next 15 years. In this report we examine why now could be the time for a global infrastructure push, and where the most exciting opportunities are by region and industry. Most importantly, though, with a need for infrastructure from a social and economic perspective and with funding keen to participate, we examine why it isn&rsquo;t happening, and what stakeholders, both government and financial, need to do to make it happen. We are faced with a rare opportunity to create and grow a new asset class, build a better world that is fit for the future, and create millions of jobs in the process; and who knows, we may just kick-start the global economy in the process. Authors: Authors: Jason Channell,Elizabeth Curmi, PhD.,David Lubin,Ebrahim Rahbari,

The dawn of a new multi-trillion dollar asset class

Throughout history, economic and social development have gone hand in hand with infrastructure development, be it the road networks and sanitation advances of the Romans (what did they do for us?), the Silk Road, or the maritime advances which led to the age of exploration and resulting global trade. Our modern era has been similarly transformed by the availability of energy, electronic communications, and modern travel which have made the world a much smaller place.

Infrastructure for Growth

Tina M Fordham

Minaggao Shen

Markus Rosgen

Shuang Ding

Enjiang Cheng

The increase in the world’s China–dependence in the past few years suggests that the imminent rebalancing of the Chinese economy will have highly visible consequences for many countries. Perhaps the central defining feature of China’s economy is its dependence on investment spending. Last year the investment/GDP ratio reached 50%, a record not only for China but also, as far as we know, for any other major economy ever. However, this extraordinary investment-orientedness is about to end, and China’s rebalancing will shift the economy away from investment spending and towards consumer spending. That’s partly for ‘natural’ reasons, to do with the decline in the efficiency of China’s investment spending, the fall in the return on capital, and the changing dynamics of China’s labor market. But in addition, we think that Chinese policymaking will help to accelerate the rebalancing process, even though it’s true that in recent years Chinese governments have promised more re-balancing than they’ve delivered. Pension reform, price reform, interest rate liberalization and other measures are now helping to raise the disposable income of Chinese households and reduce their incentives to save heavily. China’s investment-driven growth model has had a decisive impact on emerging economies in the past 10 years. It has defined the rapid growth of Asia’s regional integration: China has absorbed capital goods from Asia both as part of manufacturing production chains, as well as to satisfy China’s domestic demand. And it has helped to form a ‘China-commodities complex’, creating a high level of China-dependence for commodities exporters worldwide. The metals-intensity of China’s investment-driven growth has been particularly unique. China’s rebalancing will certainly come along with weaker growth, and this could contain a number of threats for emerging markets, in particular . These will come in three forms: i) threats to the commodities-exporters who fail to benefit from the weaker growth of China’s commodities demand and its changing composition; ii) threats to countries who lose out in China’s pursuit of vertical integration, by which China replaces foreign-supplied inputs to the production process with its own; and iii) threats to a broader group of commodity-importing countries if it turns out that a weaker, more balanced Chinese growth has a bad effect on global risk appetite . The threat to EM from a slower-growing, more consumer-driven China will depend largely on whether the rebalancing process is benign (more consumption) or not (less investment). The experiences of Japan in the 1970s and Korea in the 1990s are not encouraging in this respect: rebalancing in both these economies relied more on a fall in investment than a rise in consumption. In the longer term, the new shape of China’s links to EM will depend on i) which countries have a chance of supplying more consumer goods and services to China; ii) which countries have a chance of winning out as global production capacity relocates away from a more expensive China; and iii) which countries can withstand China’s emergence as a global competitor. Our analysis of these trends suggest that Asia is by far the best-placed to take advantage of a new pattern of Chinese growth, even if it may also be the region most at risk of a fall in Chinese investment demand. South America, by contrast, will face an adjustment process that could be painful given the appreciation of real exchange rates that the region has seen in its membership of the ‘China-commodities complex’. Mexico, Turkey, Hungary, Romania, Poland, Israel, Czech, Egypt, Ukraine and others all have a chance of surviving well.

The increase in the world&rsquo;s China&ndash;dependence in the past few years suggests that the imminent rebalancing of the Chinese economy will have highly visible consequences for many countries. Perhaps the central defining feature of China&rsquo;s economy is its dependence on investment spending. Last year the investment/GDP ratio reached 50%, a record not only for China but also, as far as we know, for any other major economy ever. However, this extraordinary investment-orientedness is about to end, and China&rsquo;s rebalancing will shift the economy away from investment spending and towards consumer spending. That&rsquo;s partly for &lsquo;natural&rsquo; reasons, to do with the decline in the efficiency of China&rsquo;s investment spending, the fall in the return on capital, and the changing dynamics of China&rsquo;s labor market. But in addition, we think that Chinese policymaking will help to accelerate the rebalancing process, even though it&rsquo;s true that in recent years Chinese governments have promised more re-balancing than they&rsquo;ve delivered. Pension reform, price reform, interest rate liberalization and other measures are now helping to raise the disposable income of Chinese households and reduce their incentives to save heavily.
China&rsquo;s investment-driven growth model has had a decisive impact on emerging economies in the past 10 years. It has defined the rapid growth of Asia&rsquo;s regional integration: China has absorbed capital goods from Asia both as part of manufacturing production chains, as well as to satisfy China&rsquo;s domestic demand. And it has helped to form a &lsquo;China-commodities complex&rsquo;, creating a high level of China-dependence for commodities exporters worldwide. The metals-intensity of China&rsquo;s investment-driven growth has been particularly unique.
China&rsquo;s rebalancing will certainly come along with weaker growth, and this could contain a number of threats for emerging markets, in particular . These will come in three forms: i) threats to the commodities-exporters who fail to benefit from the weaker growth of China&rsquo;s commodities demand and its changing composition; ii) threats to countries who lose out in China&rsquo;s pursuit of vertical integration, by which China replaces foreign-supplied inputs to the production process with its own; and iii) threats to a broader group of commodity-importing countries if it turns out that a weaker, more balanced Chinese growth has a bad effect on global risk appetite .
The threat to EM from a slower-growing, more consumer-driven China will depend largely on whether the rebalancing process is benign (more consumption) or not (less investment). The experiences of Japan in the 1970s and Korea in the 1990s are not encouraging in this respect: rebalancing in both these economies relied more on a fall in investment than a rise in consumption. In the longer term, the new shape of China&rsquo;s links to EM will depend on i) which countries have a chance of supplying more consumer goods and services to China; ii) which countries have a chance of winning out as global production capacity relocates away from a more expensive China; and iii) which countries can withstand China&rsquo;s emergence as a global competitor.
Our analysis of these trends suggest that Asia is by far the best-placed to take advantage of a new pattern of Chinese growth, even if it may also be the region most at risk of a fall in Chinese investment demand. South America, by contrast, will face an adjustment process that could be painful given the appreciation of real exchange rates that the region has seen in its membership of the &lsquo;China-commodities complex&rsquo;. Mexico, Turkey, Hungary, Romania, Poland, Israel, Czech, Egypt, Ukraine and others all have a chance of surviving well.

China is about to rebalance. How will EM be affected?

China’s investment-driven growth model has had a decisive impact on emerging economies in the past 10 years. However, this extraordinary investment-orientedness is about to end and China’s rebalancing will shift the economy away from investment spending and towards consumer spending and likely come along with weaker growth. This could create a number of threats for emerging markets and the severity of the threat will depend largely on whether the rebalancing process is benign (more consumption) or not (less investment). Our analysis suggests that Asia is the best-placed region to take advantage of a new pattern of Chinese growth, while South America could face a painful adjustment process given the appreciation of real exchange rates that the region has seen in its membership of the ‘China-commodities complex’.

China & Emerging Markets 

Dalibor Vavruska

We see the following two issues as most crucial in the battle. First, Elliott’s plan for Telecom Italia called for a fixed-line network (NetCo) spin-off as well as flexibility around infrastructure consolidation and the future control of infrastructure assets, including the NetCo. Secondly, Elliott held a view that the board should be composed of independent, mostly local business people as opposed to insiders linked to a specific industry or shareholder. We see the Telecom Italia vote as the first open shareholder vote on these highly important issues in the telecom industry. In the pages that follow, we focus on the broader implications of this unique shareholder activist victory on the telecom industry in Europe and beyond. Telecoms Under Siege Are Often Wrong To See Salvation in NetCo/ServCo Synergies The telecom industry is under major pressure. On the service side, global technology companies have pushed telecoms into retreat. On the network side, it is increasingly clear that certain assets such as towers and fiber may be best managed as a shared utility-like infrastructure (see our report Re-Birth Of Telecom Monopoly from November 2014). Infrastructure investors are becoming increasingly active in the pure telecom infrastructure space, especially in advanced economies with low density of fiber-to-the- home (FTTH). For example, we have recently seen such activity in Europe in Italy (government-backed Open Fiber established by Enel and CDP), the U.K. (recent acquisition of CityFibre by a Goldman Sachs-backed consortium), Denmark (recent acquisition of TDC by a consortium led by Macquarie) and in Germany. Telecom companies are concerned that other industries may ‘eat’ their businesses piece by piece. As a response they often cling to synergies between infrastructure and services (or NetCo/ServCo) — something that rivals from other industries cannot easily replicate. Unfortunately, we think that such combination strategies may prove short-sighted and counterproductive. First, the nature of the infrastructure and service businesses differs substantially. Second, such strategies may partially work in the short-term, allowing telecoms to operate otherwise non-competitive infrastructure and service businesses but this also requires them to retain major structural inefficiencies, making their businesses inflexible and vulnerable in the long term. Third, such strategies may put telecoms on a collision course with their regulators, who are increasingly focused on the quality (not the duplication) of infrastructure and the versatility of its use for digital services. The recent history of Telecom Italia provides a typical example of this. The plan put forward by Elliott Advisors essentially called for a departure from the NetCo/ServCo synergy-driven strategy. Instead it sees value creation from a potential breakup of the company including possible regulatory benefits. The plan would also entail the transformation of Telecom Italia’s ServCo into a competitive technology, connectivity, and service-driven business, which we call DIGITECCS. In our April 2018 report Are markets starting to envisage changing roles of telecoms and tech?, we presented data showing growing investor support for telecoms to refocus away from NetCo/ServCo synergies. This includes stock market responses to specific moves in the Czech Republic, Denmark, and New Zealand, among others. In the case of Telecom Italia, the stock market responded positively to the announcement of the Elliott Associate plans earlier this year. The instant market reaction to Friday’s victory by Elliott Advisors was also positive, despite the obvious uncertainty that will now surround Telecom Italia. Telecom Executives Can No Longer Take Investors’ Support For Their Infrastructure Control ‘Red Lines’ For Granted A question naturally arises: Do executives of telecom companies also see the above- mentioned trends? Surely it is in their interest to boost shareholder value. Telecom Italia’s highly-regarded CEO, had already presented a plan inspired by similar thinking. Does investor activism, takeovers by non-telecom investors, self-inflicted disruption, and departure from long established telecom business models really serve the best telecom shareholder interests? We provide three reasons why we think they may. First, large telecoms suffer from internal inertia, because structural changes entail significant changes in job roles, including generational changes favoring young, creative, and software/customer-focused workforce. Second, industry executives often have ‘red lines’ linked to controlling key infrastructure. Veteran telecom executives may simply not be prepared to contemplate a different type of business, irrespective of the value implications of a potential breakup. Finally, telecom executives may not have sufficient incentives to fundamentally transform or break up telecom companies. The potential rewards for doing so may simply not be high enough to compensate for the higher risk and smaller size of the business. The Telecom Italia vote in our view sends a clear signal to the entire telecom industry that a growing number of investors may no longer tolerate infrastructure control ‘red lines’, which are endorsed by many telecom insiders including boards, executives, certain business partners, consultants, investors, and analysts. If value-accretive opportunities to ‘trade’ control in some infrastructure for financial, competitive, or regulatory benefits arise, investors may want telecom companies to consider those with an open mind. In other words, they want to look at telecoms as structural and digital transformation opportunities, not only as legacy businesses. Shareholders, who voted to support the Elliott Advisor’s slate, in our view also voted for a more open mind about strategic options, despite short-term risks to the company. For those who supported the Vivendi slate, some may have been concerned about growing government involvement in Telecom Italia and, purely theoretically, potential future conflicts of interest involving Elliott’s activity in Italy (although there is nothing specific known as of now). These may be valid points, but they do not necessarily contradict the key conceptual points from Elliott’s strategic plan. Regulators and Infrastructure Investors May Strengthen the Economic Case for a NetCo/ServCo Breakup The economic case for the NetCo/ServCo breakup of telecoms may also evolve over time. It is possible that in a number of markets, it may now be approaching a point where it is hard for prudent investors to dismiss it. We see two main reasons for this: In their effort to promote investments into infrastructure shared among market players, e.g., into fiber, regulators can make the control of certain infrastructures by telecom incumbents more expensive. For example, the EU is contemplating a plan which gives certain regulatory benefits exclusively to wholesale-only independently-controlled networks. The Italian government has helped to fund Open Fiber, an independent fiber network directly challenging Telecom Italia. The U.K. telecom regulator Ofcom, has a history of pushing for independence of the incumbent’s network, i.e., Openreach. It recently also warned the incumbent operator (BT) to change and innovate, invoking historical examples of failed businesses such as Kodak, Blockbuster, and Polaroid. Infrastructure investors, who historically avoided telecoms in favor of other utility industries, are beginning to change their attitude. They are mainly looking for opportunities in independent, open infrastructure such as towers and fiber, which is seen as strategic by governments. If the leading telecoms agree to cease control in some of their infrastructure, they could potentially benefit from ‘de-risked’ valuations that such investors may put on these assets. Otherwise, infrastructure investors can pursue a route of building new open networks, undermining the leading telecoms’ infrastructure. This is currently happening in Italy, Germany, and the U.K. Five Key Questions Telecom Investors Should Ask In summary, the Elliott’s victory in the Telecom Italia shareholder vote shows that, going forward, telecom executives need to consider the interests of a growing number of shareholders who may see value creation in the NetCo/ServCo breakup. We consider building competitive strengths of the service businesses (ServCos) around a combination of DIGItal TEChnology, Connectivity and Service (DIGITECCS) in preparation for potential value accretive NetCo/ServCo breakups, as the right strategic response, especially ahead of 5G. We see telecoms, for example in the U.S., Japan, Korea, Spain, Russia, Turkey, some of the Gulf countries, and beyond, already being active in the DIGITECCS area, although with varying views about the future of telecom infrastructure. Meanwhile, amid fading shareholder and regulatory support, the leading European incumbents have found unusual allies in their trade unions. ETNO, an association of the leading European telecoms, issued a joint statement with their trade union partners last month pushing back on the proposed EU code, which could give a benefit to independent infrastructure companies and hence indirectly promote the NetCo/ServCo model. Since we see structural inefficiencies as one of the key challenges facing legacy telecoms, we view alignment with trade unions as important. We think that the following questions are crucial for telecom investors: 1. Who is management of telecom companies aligning with, which incentives does it have, what ‘red lines’ on infrastructure control does it honor and most of all, what impact does this all have on shareholder value creation? 2. Which telecom companies are most ripe for takeovers inspired by structural changes, shareholder activism, and other shareholder-driven attempts to create value through structural changes? 3. Which industries and companies will benefit from possibly prolonged inefficiencies of legacy telecoms? 4. How best do you look at telecom value creation with an open mind, not influenced by the possibly biased long held views of many telecom industry insiders? 5. If crucial shareholder votes involving proposed structural changes to incumbent telecoms occur, how should the voting shareholders assess upside from such changes against potential risks?Authors: Authors: Authors: Dalibor Vavruska,Authors: Dalibor Vavruska,Authors: Authors: Dalibor Vavruska,Authors: Dalibor Vavruska,Authors: Dalibor Vavruska,Authors: Dalibor Vavruska,

<div class="preview">
We see the following two issues as most crucial in the battle. First, Elliott&rsquo;s plan for Telecom Italia called for a fixed-line network (NetCo) spin-off as well as flexibility around infrastructure consolidation and the future control of infrastructure assets, including the NetCo. Secondly, Elliott held a view that the board should be composed of independent, mostly local business people as opposed to insiders linked to a specific industry or shareholder. We see the Telecom Italia vote as the first open shareholder vote on these highly important issues in the telecom industry. In the pages that follow, we focus on the broader implications of this unique shareholder activist victory on the telecom industry in Europe and beyond.
Telecoms Under Siege Are Often Wrong To See Salvation in NetCo/ServCo Synergies
The telecom industry is under major pressure. On the service side, global technology companies have pushed telecoms into retreat. On the network side, it is increasingly clear that certain assets such as towers and fiber may be best managed as a shared utility-like infrastructure (see our report <a href="https://www.citivelocity.com/citigps/re-birth-telecom-monopoly-2/" target="_blank" rel="noopener noreferrer">Re-Birth Of Telecom Monopoly</a> from November 2014). Infrastructure investors are becoming increasingly active in the pure telecom infrastructure space, especially in advanced economies with low density of fiber-to-the- home (FTTH). For example, we have recently seen such activity in Europe in Italy (government-backed Open Fiber established by Enel and CDP), the U.K. (recent acquisition of CityFibre by a Goldman Sachs-backed consortium), Denmark (recent acquisition of TDC by a consortium led by Macquarie) and in Germany. Telecom companies are concerned that other industries may &lsquo;eat&rsquo; their businesses piece by piece. As a response they often cling to synergies between infrastructure and services (or NetCo/ServCo) &mdash; something that rivals from other industries cannot easily replicate.
Unfortunately, we think that such combination strategies may prove short-sighted and counterproductive. First, the nature of the infrastructure and service businesses differs substantially. Second, such strategies may partially work in the short-term, allowing telecoms to operate otherwise non-competitive infrastructure and service businesses but this also requires them to retain major structural inefficiencies, making their businesses inflexible and vulnerable in the long term. Third, such strategies may put telecoms on a collision course with their regulators, who are increasingly focused on the quality (not the duplication) of infrastructure and the versatility of its use for digital services.
The recent history of Telecom Italia provides a typical example of this. The plan put forward by Elliott Advisors essentially called for a departure from the NetCo/ServCo synergy-driven strategy. Instead it sees value creation from a potential breakup of the company including possible regulatory benefits. The plan would also entail the transformation of Telecom Italia&rsquo;s ServCo into a competitive technology, connectivity, and service-driven business, which we call DIGITECCS.
In our April 2018 report <a href="https://www.citivelocity.com/citigps/are-markets-starting-to-envisage-changing-roles-of-telecoms-and-tech/">Are markets starting to envisage changing roles of telecoms and tech?</a>, we presented data showing growing investor support for telecoms to refocus away from NetCo/ServCo synergies. This includes stock market responses to specific moves in the Czech Republic, Denmark, and New Zealand, among others. In the case of Telecom Italia, the stock market responded positively to the announcement of the Elliott Associate plans earlier this year. The instant market reaction to Friday&rsquo;s victory by Elliott Advisors was also positive, despite the obvious uncertainty that will now surround Telecom Italia.
Telecom Executives Can No Longer Take Investors&rsquo; Support For Their Infrastructure Control &lsquo;Red Lines&rsquo; For Granted
A question naturally arises: Do executives of telecom companies also see the above- mentioned trends? Surely it is in their interest to boost shareholder value. Telecom Italia&rsquo;s highly-regarded CEO, had already presented a plan inspired by similar thinking. Does investor activism, takeovers by non-telecom investors, self-inflicted disruption, and departure from long established telecom business models really serve the best telecom shareholder interests? We provide three reasons why we think they may. First, large telecoms suffer from internal inertia, because structural changes entail significant changes in job roles, including generational changes favoring young, creative, and software/customer-focused workforce. Second, industry executives often have &lsquo;red lines&rsquo; linked to controlling key infrastructure. Veteran telecom executives may simply not be prepared to contemplate a different type of business, irrespective of the value implications of a potential breakup. Finally, telecom executives may not have sufficient incentives to fundamentally transform or break up telecom companies. The potential rewards for doing so may simply not be high enough to compensate for the higher risk and smaller size of the business.
The Telecom Italia vote in our view sends a clear signal to the entire telecom industry that a growing number of investors may no longer tolerate infrastructure control &lsquo;red lines&rsquo;, which are endorsed by many telecom insiders including boards, executives, certain business partners, consultants, investors, and analysts. If value-accretive opportunities to &lsquo;trade&rsquo; control in some infrastructure for financial, competitive, or regulatory benefits arise, investors may want telecom companies to consider those with an open mind. In other words, they want to look at telecoms as structural and digital transformation opportunities, not only as legacy businesses. Shareholders, who voted to support the Elliott Advisor&rsquo;s slate, in our view also voted for a more open mind about strategic options, despite short-term risks to the company. For those who supported the Vivendi slate, some may have been concerned about growing government involvement in Telecom Italia and, purely theoretically, potential future conflicts of interest involving Elliott&rsquo;s activity in Italy (although there is nothing specific known as of now). These may be valid points, but they do not necessarily contradict the key conceptual points from Elliott&rsquo;s strategic plan.
Regulators and Infrastructure Investors May Strengthen the Economic Case for a NetCo/ServCo Breakup
The economic case for the NetCo/ServCo breakup of telecoms may also evolve over time. It is possible that in a number of markets, it may now be approaching a point where it is hard for prudent investors to dismiss it. We see two main reasons for this:
<ul>
<li>In their effort to promote investments into infrastructure shared among market players, e.g., into fiber, regulators can make the control of certain infrastructures by telecom incumbents more expensive. For example, the EU is contemplating a plan which gives certain regulatory benefits exclusively to wholesale-only independently-controlled networks. The Italian government has helped to fund Open Fiber, an independent fiber network directly challenging Telecom Italia. The U.K. telecom regulator Ofcom, has a history of pushing for independence of the incumbent&rsquo;s network, i.e., Openreach. It recently also warned the incumbent operator (BT) to change and innovate, invoking historical examples of failed businesses such as Kodak, Blockbuster, and Polaroid.</li>
<li>Infrastructure investors, who historically avoided telecoms in favor of other utility industries, are beginning to change their attitude. They are mainly looking for opportunities in independent, open infrastructure such as towers and fiber, which is seen as strategic by governments. If the leading telecoms agree to cease control in some of their infrastructure, they could potentially benefit from &lsquo;de-risked&rsquo; valuations that such investors may put on these assets. Otherwise, infrastructure investors can pursue a route of building new open networks, undermining the leading telecoms&rsquo; infrastructure. This is currently happening in Italy, Germany, and the U.K.</li>
</ul>
Five Key Questions Telecom Investors Should Ask
In summary, the Elliott&rsquo;s victory in the Telecom Italia shareholder vote shows that, going forward, telecom executives need to consider the interests of a growing number of shareholders who may see value creation in the NetCo/ServCo breakup. We consider building competitive strengths of the service businesses (ServCos) around a combination of DIGItal TEChnology, Connectivity and Service (DIGITECCS) in preparation for potential value accretive NetCo/ServCo breakups, as the right strategic response, especially ahead of 5G. We see telecoms, for example in the U.S., Japan, Korea, Spain, Russia, Turkey, some of the Gulf countries, and beyond, already being active in the DIGITECCS area, although with varying views about the future of telecom infrastructure. Meanwhile, amid fading shareholder and regulatory support, the leading European incumbents have found unusual allies in their trade unions. ETNO, an association of the leading European telecoms, issued a joint statement with their trade union partners last month pushing back on the proposed EU code, which could give a benefit to independent infrastructure companies and hence indirectly promote the NetCo/ServCo model. Since we see structural inefficiencies as one of the key challenges facing legacy telecoms, we view alignment with trade unions as important. We think that the following questions are crucial for telecom investors:
1. Who is management of telecom companies aligning with, which incentives does it have, what &lsquo;red lines&rsquo; on infrastructure control does it honor and most of all, what impact does this all have on shareholder value creation?
2. Which telecom companies are most ripe for takeovers inspired by structural changes, shareholder activism, and other shareholder-driven attempts to create value through structural changes?
3. Which industries and companies will benefit from possibly prolonged inefficiencies of legacy telecoms?
4. How best do you look at telecom value creation with an open mind, not influenced by the possibly biased long held views of many telecom industry insiders?
5. If crucial shareholder votes involving proposed structural changes to incumbent telecoms occur, how should the voting shareholders assess upside from such changes against potential risks?Authors: Authors: Authors: Dalibor Vavruska,Authors: Dalibor Vavruska,Authors: Authors: Dalibor Vavruska,Authors: Dalibor Vavruska,Authors: Dalibor Vavruska,Authors: Dalibor Vavruska,
</div>

Citi GPS Opinion

Last Friday, Elliott Advisers, an activist investor with a 9% stake in Telecom Italia, won a shareholder vote that secured two-thirds of the Italian incumbent’s board seats for its proposed candidates made up mostly of independent Italian business figures. This was the first proxy shareholder vote victory in Elliott’s 40- year history. Its rival, Vivendi, effectively lost control of the board by winning only one- third of the seats, despite owning 24% of Telecom Italia and being backed by the current popular CEO. It was a close win in a widely-watched shareholder battle. Unsurprisingly, the battle was full of mutual accusations of corporate governance failings and inconsistent communication. Some papers characterized the battle as a fight for the future of modern capitalism. Vivendi focused on stability and its alignment with the current CEO. Meanwhile, Elliott managed to secure support of the leading proxy advisors on corporate governance grounds. The Italian government, which indirectly owns almost 5%, also supported the Elliott slate.

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