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Paper tigers: Chinese and Indian capital marketsJune 2014 Dr. Paul Kielstra
Deutsche Asset & Wealth Management
S6 SPECIAL ISSUE
Paper tigers: Chinese and Indian capital markets2
Deutsche Asset & Wealth Management’s Global
Financial Institute asked the Economist Intelli-
gence Unit to produce a series of white papers,
custom articles, and info-graphics focused spe-
cifically on global capital market trends in 2030.
While overall growth has resumed, and the
value traded on capital markets is astoundingly
large (the world’s financial stock grew to $212
trillion by the end of 2010, according to McKin-
sey & Company) since the global financial crisis
of 2008, the new growth has been driven mainly
by expansion in developing economies, and
by a $4.4 trillion increase in sovereign debt in
2010. The trends are clear: Emerging markets,
particularly in Asia, are driving capital-raising; in
many places debt markets are fragile due to the
large component of government debt; and stock
Global Financial Institute
Introduction to “Global Capital Markets in 2030“
markets face weakening demand in many mature
markets.
In short, while the world’s stock of financial assets
(e.g. stocks, bonds, currency and commodity
futures) is growing, the pattern of that growth sug-
gests that major shifts lie ahead in the shape of capi-
tal markets.
This series of studies by Global Financial Institute
and the Economist Intelligence Unit aims to offer
deep insights into the long term future of capital
markets. It will employ both secondary and primary
research, based on surveys and interviews with
leading institutional investors, corporate executives,
bankers, academics, regulators, and others who will
influence the future of capital markets.
Paper tigers: Chinese and Indian capital markets3
About the Economist Intelligence Unit
The Economist Intelligence Unit (EIU) is the
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the leading source of analysis on international
business and world affairs.
This article was written by Dr. Paul Kielstra and
edited by Brian Gardner.
Dr. Paul Kielstra is a Contributing Editor at the
Economist Intelligence Unit. He has written on
a wide range of topics, from the implications of
political violence for business, through the eco-
nomic costs of diabetes. HIs work has included
a variety of pieces covering the financial services
industry including the changing role relationship
between the risk and finance function in banks,
preparing for the future bank customer, sanctions
compliance in the financial services industry, and
the future of insurance. A published historian, Dr.
Kielstra has degrees in history from the Universi-
ties of Toronto and Oxford, and a graduate diploma
in Economics from the London School of Econom-
ics. He has worked in business, academia, and
the charitable sector.
Brian Gardner is a Senior Editor with the EIU’s
Thought Leadership Team. His work has covered a
breadth of business strategy issues across indus-
tries ranging from energy and information tech-
nology to manufacturing and financial services. In
this role, he provides analysis as well as editing,
project management and the occasional speaking
role. Prior work included leading investigations
into energy systems, governance and regulatory
regimes. Before that he consulted for the Commit-
tee on Global Thought and the Joint US-China Col-
laboration on Clean Energy. He holds a master’s
degree from Columbia University in New York City
and a bachelor’s degree from American University
in Washington, DC. He also contributes to The
Economist Group’s management thinking portal.
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4
In recent decades, the overarching economic story out of
Asia has been the transformation of the continent’s demo-
graphic giants into economic ones. This has happened on
any number of levels. For example, in recent years in nomi-
nal GDP terms China has surpassed Japan to become the
world’s second largest economy, and India already is the
world’s tenth largest GDP. Only a decade ago, China and
India were in 6th and 13th place, respectively.
Dramatic growth can also be seen in the two countries’
capital markets. Today, Shanghai and Shenzhen combined
have a greater market capitalisation than that of any other
country’s exchanges except those of the United States.
India’s collective total, meanwhile, lags behind only those
of America, China, Japan, the United Kingdom and Hong
Kong. In terms of total securities, India has far more firms
listed – over 5,100 on the Bombay Stock Exchange alone
– than any other country; the NASDAQ and the NYSE col-
lectively have a little over 4,100 domestic companies,
although cross listing means the total number is somewhat
lower. The two Chinese exchanges have fewer listings, but
have seen faster growth in their number. Between 2009 and
2011, according to Dealogic, they were both in the top five
exchanges for initial public offerings by value, and in 2012
remained in the top 10. More broadly, Shanghai and Shen-
zhen also saw the fourth and fifth highest levels of share
trading by value globally last year.
A number of indicators point to continued growth. China
currently has among the highest gross savings rates in the
world (51% in 2012 according to the World Bank) which
represents an increase on the roughly 40% of the 1990s.
The country is putting capital to work privately and pub-
licly: the World Bank calculates China’s gross fixed capital
formation at 47% of GDP in 2012, with absolute spending in
this area more than a quarter higher than that of the United
States that year. India’s gross savings rate is a comparatively
modest 34%, but it, too, has a substantial amount of money
in search of effective allocation. And with a gross fixed capi-
tal formation rate of 30%, India has plenty of opportunity
for investment.
Paper tigers: Chinese and Indian capi-tal marketsA Global Financial Institute research paper written by the Economist Intelligence UnitJune 2014
Paper tigers: Chinese and Indian capital markets Global Financial Institute
Written by
65 %
53 %
35 %
24 %
22 %
21 %
19 %
8 %
8 %
3 %
5 %
United States
China
India
Japan
United Kingdom
Brazil
Germany
France
Italy
Other, please specify
Capital will be so international that location will have little relevance
Which of the following economies do you think will have the most important public equity markets for the global economy by 2030? Please select up to three.
Source: The Economist Intelligence Unit (August 2013)
5 Paper tigers: Chinese and Indian capital markets
It is not surprising, then, that China and India’s capital markets
seem poised to take on significant global importance. According
to a 2013 Economist Intelligence Unit survey of over 350 compa-
nies active in global capital markets, 53% say that China will be
among the countries with the world’s leading equity markets by
2030, and 35% say the same of India. That would make these two
countries the second and third top equity markets in 2030, after
the United States, in the estimation of global executives. On bond
markets, China came second (45%) while India was sixth (24%).
That said, China’s and India’s capital markets institutions
are a long way from being global players. Even in their
domestic roles, these markets are often not efficiently allo-
cating the substantial capital being saved. A 2013 study by
World Bank researchers found that “the expansion of finan-
cial market activity since the 1990s has been more limited
than…the aggregate figures suggest.” A handful of large
companies have dominated activity on equity and bond
markets, with the top 10 firms in India and China account-
ing for 62% and 43% respectively of the capital raised
between 2005 and 2010.1
If anything, debt markets in India are even less developed
than equity ones. The Indian government, in its 2012-2013
budget economic survey admits, “Though, the develop-
ment of the corporate bond market, has been an impor-
tant area and has received greater policy attention in
recent times, it is yet to take off in a significant manner.” The
country’s Economic Times newspaper goes further, citing
low trading levels, poor liquidity in the secondary market,
and a lack of interest by banks in corporate debt, it calls the
country’s corporate bond market “a mirage”.2
In contrast, China’s bond markets have seen substantial
growth in the recent years and are the fourth largest in the
world in absolute size. They are still dominated by govern-
ment debt rather than funding more diverse private sector
endeavours. According to the Asian Development Bank,
at the end of 2013 the total of all corporate bonds repre-
sented 15% of national GDP. This is more than double the
2008 figure, but still well below the equivalent number for
the United State (around 60% in 2013). Moreover, the vast
majority of Chinese corporate bonds are “enterprise bonds”
issued by government affiliated companies. Traditional
corporate bonds can be issued by smaller, private firms but
that market is thinly traded and highly illiquid. The ability
of organisations without strong state connections to tap
bond markets remains an open question.
1 Tatiana Didier, Sergio Schmukler, “The Financing and Growth of Firms in China and India: Evidence from Capital Markets,” World Bank Policy Research Working Paper 6401, April 2013.2 “Indian corporate bond market still remains a mirage”, 28 November 2012.
Global Financial Institute
68 %
45 %
30 %
28 %
26 %
24 %
12 %
10 %
9 %
3 %
4 %
United States
China
Japan
United Kingdom
Germany
India
Brazil
France
Italy
Other, please specify
Capital will be so international that location will have little relevance
Which of the following countries do you think will have the most important bond markets for the global economy by 2030? Please select up to three.
Source: The Economist Intelligence Unit (August 2013)
6 Paper tigers: Chinese and Indian capital markets
Moreover, the transparency of the Chinese bond markets is
a significant worry. Not a single bond has seen a default, in
part because the government and other interested parties
have stepped in on occasion to make good insolvent par-
ties. This makes pricing risk a fraught endeavour. In Octo-
ber 2012, the IMF highlighted that “the apparent pattern
of ‘higher returns and suppressed default risk’”, already a
worry amongst trust companies and alternative lenders,
has extended to the bond market.3
Overall, then, capital markets in these countries are deliv-
ering less than they appear to on the surface. Professor
Venkatesh Panchapagesan of the Indian Institute of Man-
agement says, “India has had 10 to 15 years of phenomenal
growth, but capital markets have not been the primary
driver. The exchanges, institutions and intermediaries have
not been able to do a good job.” In China, especially for
smaller, private entrepreneurs without political connec-
tions, the situation is very much the same.
Common weaknessesA number of issues present in both countries greatly dimin-
ish the attractiveness of their capital markets to investors
and companies alike. In recent years especially, one such
problem has been that capital markets are unlikely des-
tination for investors looking to profit from Chinese or
Indian growth. Markets around the world all saw substan-
tial drops in 2008 and some recovery in 2009. Since then,
however, despite steady, robust economic growth in each
country, India’s volatile equities have failed to keep pace
with economic growth in the country and China’s stock
indices have even seen substantial overall declines [See
Table]. Looking more closely over the last decade, a rapid
expansion of the number of listed companies helped drive
the increase in market capitalisation for Shenzhen and the
NSE rather than this arising from rising share price alone.
Economic growth and market indices are only loosely
related in most circumstances. Nevertheless, the weak
showing of these markets, especially in China, brings con-
cerns for those potential investors otherwise willing to
overlook institutional deficiencies.
One such deficiency is the poor level of investor legal pro-
tections and legal enforcement. Stock scandals have been
all too common. Chinese authorities have pursued a well-
publicised crackdown in this area, which has included a
freeze on initial public offerings (IPOs) between October
2012 and January 2014. Meanwhile, in April 2013, three
arrests were made in a high-profile bond market scandal.
The March 2013 comments of Zong Qinghou, China’s rich-
est man, to the Wall Street Journal sum up the attitude
such activity has created in the country. “When the ordi-
nary people invest in it, the market should reward them
with some benefits. But it does not,” he says. “Speculation
has totally cheated ordinary investors of any benefits.”4
3 Global Financial Stability Report, October 2012.4 “China’s Richest Man Says Capital Markets ‘Suck’”, China Real Time Report, Wall Street Journal, 5 March 2013, http://blogs.wsj.com/chinarealtime/2013/03/05/capital-markets-suck-says-chinas-richest-man/
Global Financial Institute
Country Projected real GDP growth 2010 – 2013
Selected Stock Market Indices January 2010 – December 2013
China 40% Shanghai Composite Index -36% Shenzhen Component Index -11
India 27% NSE Nifty CMX +20% BSE Sensex +19%
United States 9% DJIA +55% United Kingdom 5% FTSE 100 +22%
Economic growth and market indices are only loosely related in most circumstances. Nevertheless, the weak showing of these markets, especially in China, brings concerns for those potential investors otherwise willing to overlook institutional deficiencies. Source: The Economist Intelligence Unit (February 2014)
7 Paper tigers: Chinese and Indian capital markets
India has also had its share of business corruption, as Mr
Panchapagesan puts it, “regulators have not been able
to provide confidence to investors as scandals come up
on a periodic basis.” Even the CEO of the National Stock
Exchange agreed in an interview last year that insider trad-
ing is “rampant,”5 and in August 2012, a government minis-
ter revealed that three regulatory officials from the Securi-
ties and Exchange Board of India (SEBI) itself were being
investigated for corruption.
Such problems are not unique to these two countries, and
the authorities are at least taking some steps to address
them. Nevertheless, cleaning up the markets is absolutely
essential for them to grow, as investors in both countries
are already accustomed to seeking profits elsewhere.
In this case, though, the particular vehicles vary by coun-
try. Traditionally, savers in China had little option but low-
paying accounts in state-owned banks. In the last decade
the products available have diversified rapidly but, Simon
Gleave – regional head of financial services, KPMG Asia-
Pacific – notes, bank deposits remain popular. “Investment
sophistication is pretty low,” he adds. This is exacerbated by
government restrictions on interest rates and capital flows.
Those looking for other choices have tended to put money
into real estate – a property bubble is another issue facing
the country – or into trust companies.
The latter are private companies that promise high returns
often attained via lending to companies where state-
owned banks will not. As the government has tried to
reduce lending in recent years by political fiat, such institu-
tions have filled the gap. In January 2014, meanwhile, the
People’s Bank of China reported that the shadow bank sec-
tor provided more than 30% of aggregate financing for the
whole economy, up from 23% a year earlier. Worse still, the
country has seen worrying growth in completely unregu-
lated informal lenders. The IMF estimated in October 2012
that collectively such loans totalled the equivalent of 6% to
8% of GDP, with interest rates often upwards of 20%.
A majority of household savings in India also goes into
banks, which have traditionally paid little real interest.
According to SEBI, out of a population of over 1bn, just
18 million Indians own equities, and only a small percent-
age of household savings are held in shares, mutual funds,
and government debt. Nor is this spread across the coun-
try: most of the money comes from a single city, Mumbai.
Indians looking for better returns than found in banks or
life insurance choose gold. Although this partly reflects the
cultural importance of the metal in the country, it is also
very much an investment choice. A report by Morgan Stan-
ley in June 2012 found that between 2008 and 2011 the
value of gold purchases totalled eleven times the money
going into equities and by the latter year it accounted for
10% of household savings. In June 2013, the finance min-
ister publicly encouraged Indians to stop buying so much
gold, for good reason: in the fiscal year ending March 2013
half of the country’s current account deficit came from the
import of $54 bn worth of the metal. Since the summer,
Indian gold imports have dropped due to increased gov-
ernment restrictions and duties, although purchases of
silver have risen. Now the Chinese may have caught the
gold bug as well: lower purchases by Indians and a rapidly
growing interest in the metal among Chinese made the lat-
ter the world’s largest importers of gold in 2013.
If savers are looking to invest outside of capital markets,
companies also often prefer to look elsewhere for fund-
ing. Bank loans have a number of advantages over other
financing. Mr Panchapagesan explains, “The Indian bank-
ing system is highly relationship driven. Firms can get all
kinds of sweet deals. In India creditors don’t force firms into
bankruptcy. If a business gets in trouble, they call the bank
and restructure loan. If I am a CEO, why would I go to the
capital markets where I have to be transparent? I go to my
bank, where I am not penalised even if I don’t pay.” Further-
more, large corporate groups often tap into retained earn-
ings as such activity arouses little shareholder opposition
in India
Similarly in China, large companies often find exchanges an
unappealing place to seek capital. Corporate savings rates
in China are already high – for much of the last decade they
have been around the same proportion of GDP as house-
hold savings. Financing from retained earnings can be an
easy option, especially for bigger firms. As for those which
need cash, says Mr Gleave, “bank loans are much cheaper
Global Financial Institute
5 “Insider trading: Large corporates should come together to decide on disclosure code, says Ravi Narain, NSE”, Economic Times, 11 March 2013.
8 Paper tigers: Chinese and Indian capital markets
and easier. They don’t see any point in raising capital. Why
bother with all the costs?”
In both China and India, then, poor capital market results
in recent years and ongoing corruption issues are likely to
continue underpinning business preferences for raising
capital via bank loans, and investor preferences for other
investment vehicles.
Differing paths
Each country also has specific issues that will inhibit the
ability of their capital markets to take on a global role.
For China, this begins with the extent of restriction on
exchange activity. The shares available in Shanghai and
Shenzhen are, for the most part, minority listings of state-
owned companies or their subsidiaries. Mr Gleave notes
that this “is something that needs to change before you
can build bigger equity capital markets. The government
is determined not to sell majority stakes.” Meanwhile,
growth-oriented small and mid-sized enterprises face
regulatory hurdles to listing and accessing capital through
these markets.
Another core problem is the restrictions facing inves-
tors wishing to directly access Chinese markets. China
has a highly regulated financial sector, a non-convertible
currency, and allows little access by foreigner investors
to its capital markets except through a number of limited
schemes. The government mulls reform, but as Mr Gleave
explains, the “question is what steps to take to achieve
[open markets] and in which order. Do you deregulate the
exchange rate or interest rate first? Do you reform equity
markets first? Do you open the currency or float it first?
These are fundamental question marks over how you go
from quasi state controlled financial markets to free ones.”
Real progress will have to await officials deciding on a more
comprehensive roadmap. Mr Gleave says that government
officials are currently debating these matters intensely, but
he does not expect any detailed decision on them for a
year or two. Even then, the result will inevitably be experi-
mental, as no country has ever taken this path before.
The problem for Indian companies is not related so much
to market access; the country has more equity market list-
ings than any other. Rather, Indian markets’ suffer from a
marked lack of liquidity despite high national savings rates.
Of the roughly 5,100 firms listed on the BSE, over 2,000 are
described by the exchange as “illiquid”. The more active
National Stock Exchange of India formally labels about a
quarter of its approximately 1,600 listings the same way.
These, though, are the most extreme cases, with many
other shares seeing scant activity. India’s newest stock
Global Financial Institute
Relative movement of NSE Nifty and BSE Sensex Indices and Rupee-Dollar Exchange rate (All indexed with 1 May 2013=100)
Nifty BSE Sensex Rupee vs Dollar
01-May-13 01-Jun-13 01-Jul-13 01-Aug-13 01-Sep-13
110
100
90
80
70
Source: The Economist Intelligence Unit (October 2013)
9 Paper tigers: Chinese and Indian capital markets
exchange, the MCX-SX, opened for business in February
2013, and in its initial month saw trading in only 71 of the
1,118 listed shares.
In practice, most estimates say that only a few hundred
of the largest Indian companies can be described as truly
liquid. Mr Panchagesan notes, “These are the household
names. The others are not going to grow.” Incidents of
stock fraud among thinly traded shares do little to enhance
their attractiveness. As for secondary debt and deriva-
tive markets, liquidity is even tighter. The country’s major
exchanges even offer incentives to derivative traders to
use their facilities in a bid to improve liquidity.
Perhaps as a result of this need for capital, foreign invest-
ment restrictions in India have for some years been far less
than those in China. Registered Foreign Institutional Inves-
tors (FIIs) can in aggregate buy up to 24% of the equity in
almost every Indian company. In practice, the restrictions
are even looser, with some 300 companies having special
exemptions allowing FIIs to purchase anywhere from 30%
to 100% of capital. According to the Reserve Bank of India,
only five companies currently cannot receive further FII
investment and 15 have reached their limit of investment
from non-resident Indians or persons of Indian origin.
Easy access for foreign funds can bring dangers as well
as benefits, in particular because low domestic invest-
ment gives this money outsized influence in Indian capi-
tal markets: roughly a third of the daily turnover on the
National Stock Exchange is driven by FII activity. Events
from the summer of 2013 are a notable example of what
can happen. Starting in late May, India’s equity markets
and currency saw marked instability [see chart]. This has
had little to do with the country’s economic fundamentals,
although a growing current account deficit was already
affecting confidence in May and continued throughout the
period. Instead, the announcement late in that month by
the United States’ Federal Open Market Committee that it
planned to taper quantitative easing led nervous foreign
investors to repatriate money in anticipation of possible
turmoil on American and world markets.
The majority of such activity was in June, with FIIs taking
selling off $5.6bn worth of debt and $1.8bn worth of equi-
ties. Stock market indices dropped as did the value of the
rupee in the face of substantial capital repatriation. The
sell-off continued at a slower pace in July but in the first
half of August FIIs, although continuing to be net sellers
of Indian debt, were putting money back into the coun-
try’s equities. Then, on 16 August, the government, wor-
ried about continued pressure on the rupee, announced
limited controls on Indian companies investing abroad.
This sparked rumours that broader currency controls on
foreign investors in India were under consideration, lead-
ing to another round of selling: $1.1bn in FII money left
equity markets by the month’s end while FII debt divest-
ment continued apace.
Government assurances that no such controls were in the
offing; the appointment of Raghuram Rajan – known to be
in favour of further foreign investment – as governor of the
reserve bank on 4 September; and the latter’s rolling back
of controls on Indian companies as well as bringing in fur-
ther liberalisation of certain foreign investment rules has
changed perceptions From Rajan’s appointment to mid-
September, net FII debt divestment has slowed to a trickle,
and FIIs put $1.1bn back into Indian equities.
Broad lessons from these events should be drawn with
caution. They certainly show the potential influence of
foreign money – and therefore foreign crises – on Indian
capital markets, but last summer may not be represen-
tative. An IMF study of FII investment in Indian markets
between 2000 and 2011 found little evidence that changes
in foreign investment as a result of long tail events abroad
affected Indian equity values.6 Moreover, the summer FII
sell off has to be seen in perspective: from January to mid-
September 2013, FIIs were responsible for a net inflow of
$12.6bn in equities and the outflow on the debt side has
been $1.6bn. In other words, even where outside condi-
tions were worrying, foreign investors seem to have been
prudentially reducing their holdings rather than abandon-
ing the country.
Similarly, the speedy imposition of currency controls on
Indian companies abroad might suggest that, if highly
pressed Indian policy makers may restrict investor freedom
6 Ila Patnaik, Ajay Shah, Nirvikar Singh, “Foreign Investors Under Stress: Evidence from India,” IMF Working Paper WP/13/122, May 2013.
Global Financial Institute
10 Paper tigers: Chinese and Indian capital markets
just when foreigner might need their capital most. On the
other hand, the damage caused by rumours, the rapid
reversals of these measures and disowning of controls on
foreigners, and the attendant recovery in equity values and
the rupee might equally suggest that the government has
shown a strong commitment to free markets even while
under stress and seen the rewards.
At the very least, though, events of last summer’s events
show that the large proportion of foreign capital in Indian
capital markets adds to the risks which potential investors
need to consider.
The different problems and investor preferences in the
two countries each lead to their own kind of inefficiency.
China’s large pool of capital is finding ways to fund eco-
nomic development outside of traditional capital markets.
This is positive in some ways: a low cost of capital for gov-
ernment has enabled extensive infrastructure develop-
ment that might not otherwise have been possible. On the
other hand, whether capital is being allocated efficiently
is far less clear. In India, on the other hand, savings are not
translating into substantial liquidity, despite an openness
to foreign investment. Money is more likely to go into gold
than into shares.
ConclusionAsia’s emerging giants clearly have the potential to estab-
lish capital markets of global importance. Change is occur-
ring at the margins and both countries have taken steps
to curb corruption. India recently appointed a Standing
Council of Experts on the international competitiveness
of the Indian financial sector, tasked with, among other
things, looking at capital market reform. In July 2013, the
Chinese government nearly doubled the aggregate allow-
able quota under the Qualified Foreign Institutional Inves-
tor (QFII) scheme – the main vehicle for allowing foreign
money to enter Chinese markets – though the new total
of $150bn is still relatively small and by early 2014 only
roughly a third of that amout had been issued in actual
QFII licenses. Furthermore the government has relaxed
restrictions that required at least 80% of foreign assets be
held in fixed income assets.
However for the capital markets of these countries to
become global actors more change will be needed. Both
countries need institutional strengthening so that inves-
tors are able to trust companies seeking money on equity
and debt exchanges. Doing so holds out the possibility of
much more efficient capital allocation, and therefore more
sustainable growth. Nevertheless the agenda is long and
daunting, if Dalal Street is to join Wall Street, or Lujiazui the
City, as leading global capital markets by 2030.
Global Financial Institute
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ment constitute the author’s judgment at the time of issue and are subject to change. The value of shares/units and their
derived income may fall as well as rise. Past performance or any prediction or forecast is not indicative of future results.
Any forecasts provided herein are based upon the author’s opinion of the market at this date and are subject to change,
dependent on future changes in the market. Any prediction, projection or forecast on the economy, stock market, bond
market or the economic trends of the markets is not necessarily indicative of the future or likely performance. Investments
are subject to risks, including possible loss of principal amount invested.
Publication and distribution of this document may be subject to restrictions in certain jurisdictions.
© Deutsche Bank · June 2014
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R-34277-1 (3/14)
Global Financial Institute
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