By Inti Landauro and Andres Gonzalez

MADRID (Reuters) - Spanish telecom giant Telefonica's board agreed on Saturday to appoint defence company Indra's chairman Marc Murtra as its new CEO, replacing Chief Executive Jose Maria Alvarez-Pallete following a request from state-owned fund SEPI.

Telefonica's board held an extraordinary meeting on Saturday to decide to terminate Alvarez-Pallete's contract and offer his job to Murtra, who accepted it, the company said in a filing to the stock market regulator.

The decision still needs to be ratified by shareholders, the company said.

State-owned investment fund SEPI had proposed to replace Alvarez-Pallete, who has led the company since 2016, with Murtra, a person with knowledge of the matter told Reuters earlier on Saturday.

The current term of Alvarez-Pallete was due for renewal this year at the annual general shareholders meeting usually held in April or May.

Under Murtra, Indra, which is 28% owned by the Spanish government, has focused on its defence and aerospace business to benefit from European countries' increased military budgets following heightening world tensions.

The Spanish government bought a 10% stakeworth about 2.3 billion euros ($2.36 billion) in Telefonica through SEPI in May 2024 to counterbalance the acquisition of a similar stake by Saudi Arabia's STC in late 2023.

The acquisition gave the government a seat on Telefonica's board.

Given Telefonica is considered a defence service provider and therefore a strategic company, the government only approved the transaction in November 2024 after securing a stake in the telecom company similar to STC.

Over the past years, Telefonica, like rivals in Europe, has faced a squeeze on profitability from fierce competition and the need for hefty investment in infrastructure for the 5G next-generation mobile technology.

It has been selling stakes in more mature businesses such as submarine cables or mobile masts and smaller operations in Latin America to fund 5G and optic fibre.

($1 = 0.9736 euros)

(This story has been refiled to update the headline)

(Reporting by Inti Landauro, Andres Gonzalez and Ana Cantero; editing by David Evans and Tomasz Janowski)