"The challenge was that private equity was an unknown animal," says Ashish Dhwan, now senior managing director of ChrysCapital, "Convincing promoters, used to making all the decisions, to take private equity was difficult and for a long time it was simply viewed as interference capital." ChrysCapital were among the early pioneers of private equity in India, and the company's growth, from simply trying to sell the idea of private equity to nervous entrepreneurs, to managing over $2.25bn across five funds, is one of the best illustrations of the success that private equity has achieved in India. In a little over a decade since the first major funds started dipping their toes in the water, private equity has forged an impressive relationship with the Indian growth story which has seen India's private equity sector graduate to the big league. From a mere $20m in investment in 1996, private equity has witnessed phenomenal growth in India and, with the arrival of a record number of players over the past year and further loosening of the remaining restrictions on FDI, some projections estimate that by 2010 private equity investment into the country will have swollen to in excess of $20bn. This would represent an astonishing 1000% increase over the period and place India firmly amongst the top 10 private equity destinations worldwide. Fund sizes have grown exponentially, deals have got bigger and the depth of opportunity in the country has attracted the attention of most of the world's major private equity firms. Goldman Sachs, Warburg Pincus, Blackstone and Carlyle and many others have all now staked out a significant presence in the country.

However, given the grim current global financial situation, a sharp markdown in valuations since the start of the year and the general weak state of the equity markets, the Indian private equity sector is facing its biggest challenge since the dot com era. The collapse of Carlyle Group's publicly traded mortgage-focused fund, Carlyle Capital, in early March, sent shockwaves through the global PE fraternity and with a host of hedge funds also in trouble there is considerable concern as to how liquidity pressures in developed markets, and the US in particular (from which an estimated 45% of private equity is sourced) will effect allocations to India. "Whilst, on one hand many of the institutions that also invested heavily in the global hedge funds, and that are now reeling from losses on account of the sub-prime crisis, may be forced to renege on their commitments to emerging markets, the urgency to diversify beyond markets such as Western Europe and North America has heightened interest in emerging economies such as China and India," notes Yassin Khodadeen of Aloe Private Equity.

Importantly, the correction in the domestic stock market has also eased valuations of target companies for private equity investments. According to one report by IndusView, an India-focused, cross-border advisory firm, India witnessed private equity investments to the tune of $4bn in the first three months of this year, an increase over the same period in 2007. "With the economic downturn in developed economies intensifying, and the application of capital becoming dearer and pressurising the expected return on investments, private equity firms are finding their way in to safer investment heavens, that is, emerging markets which have decoupled from the developed markets," said IndusView's chairman Bundeep Singh Rangar. Still, many of these deals would have been already at an advanced stage of completion, thus avoiding much of the market backlash. As such, others suggest that more time is needed before concluding that it is full steam ahead for Indian private equity. Indeed, perhaps more telling are the deals that haven't happened: Already this year, both Indivision India Partners' (the private equity arm of Mumbai-based Future Group's) announced investment to buy a 4.9% stake in the satellite television company, DishTV India, and ICICI Venture's $800m investment in Jaypee Infratech fell through because of market corrections after the agreements were announced, but before they could be completed. Depending on the fortunes of the market and the strength of any revival, the fate of deals over the next few months is therefore most likely to be shaped by the willingness of company promoters to back down from last year's valuation levels, which, on an average, soared 50-60%. "There has been a correction, and so it will take a little while to see how entrepreneurs can adjust to new valuation levels," says Dhawan.

The other question of importance is what might happen to private equity returns. Those private equity funds with planned exits this year will be affected by weakened valuations following the market correction and according to Dhawan, unless there is a quick change in market conditions, which he sees as unlikely, then funds will have to expect lower returns - about 23-25%, as opposed to the 30-35% that they have recently enjoyed. "People were overpaying and, as markets decline, they realise that eking out returns from those transactions will be difficult," he says.

In an effort to maximise returns in this more challenging environment, many believe that fund managers will have to return to the basics of private equity investing; with greater sectoral focus, greater attention to the due diligence done on deals and with valuations based on the future fundamentals of businesses rather than on prevailing stock market prices. The necessity for such newfound rigour is, however, liable to expose the relative immaturity of the sector. Many of the new arrivals, fresh in the country and in a scramble to attract talent, are still very much finding their feet in the country. "Private equity in India is at a very early stage," comments Deepak Shahdadpuri, managing director of Beacon India Advisors: "It's not like the US where you'll find over 3,000 funds operating in their own niches specified by region, stage and sector. India will no doubt get there but at this early stage one has to remain opportunistic," he says. "We would like to go out there and say let's get a focus in infrastructure, in health care and so on, but one needs to bear in mind the political overlay - there is a coalition government - and regulatory swings mean that it is prudent to remain opportunistic for the time being."

Thankfully, opportunity is perhaps the one thing that is unlikely to dry up any time soon. While the overall India growth story remains intact, a level of entrepreneurship that is evidently world class will ensure that India will continue to attract the attention of private equity with a steady supply of investment-worthy companies. The relative merit of the opportunities India offers in a global context is sure to drive the industry's growth for years to come and a brief cooling in activity allowing new players to redefine strategies is perhaps what's best for the industry in the long-term as Indian private equity braces itself for take-off.