A large US private equity fund recently backed out of its commitment in a South-based firm owing to differences over valuations. This is not an isolated case. Private equity funds are becoming choosy in their picks and are not hesitating to call off a deal even after signing the term-sheet.

Anoop Seth, co-head of Asian Infrastructure at AMP Capital Investors, says the macro environment has undoubtedly become tougher for companies over the last few months. Naturally, private equity funds will be more selective and will focus more on partnering with high-quality management teams," he says.

After seeing a high of 21,000 in January, the BSE Sensex, the benchmark for Indian stock markets, has been on a downslide. The public markets have corrected by 40 -50 per cent across sectors this year.

J M Trivedi J M Trivedi, Partner Actis-Head, Actis South Asia, says private equity valuations are gradually correcting but have not yet corrected fully.

There is always a gap between stock market correction and PE valuation corrections. However, Trivedi admits that deal closures are difficult in this market environment mainly because of valuations.

Rajeev Gupta Rajeev Gupta, managing director, Carlyle India Advisors. Says it is logical to ask for an adjustment in valuations. "Our analysis suggests that the present fall is a logical correction. If you do the maths at the current valuations, the inference would be that investors are demanding 16-17 per cent equity returns in the current interest rate environment of 9 per cent, while the corresponding number for last year, when the interest rate environment was more benign, was in the 12-13 per cent range," he says.

In the first six months of 2008, PE firms invested about $6.7 billion (across 193 deals) as against $5.4 billion invested (across 181 deals) during the corresponding period in 2007. PE firms invested $14.3 billion across 420 deals during whole of 2007, according to Venture Intelligence data. Though the first half of this year has seen higher growth in terms of number and size of deals, the year is likely to be end at a slower growth rate as compared to the previous year.

Ravi Menon Ravi Menon, CEO, Specialist Investments, HSBC Private Equity Advisors (India), says the full cost impact will be known when the first quarter results are out.

Another big issue in a falling stock market in India, which is largely a PIPE (private investment in public equity) market, is the floor pricing set by Sebi, which would be at large premiums to where these stocks are currently trading.

Says Gupta ,"Issuers want to issue capital, PEs want to invest, but regulations are stopping the deals. There is a fit case for review of regulations."

Although some PE players see the need for a further correction in the telecom and hospitality sectors, other believe that sectors, which ride domestic demand, are attractive in the medium to long term.

"Sectors such as infrastructure and healthcare where there is a huge unmet need are very interesting," says Nitin Deshmukh, head-private equity, Kotak Investment Advisors.