The International Finance Corporation plans to repeat in 2008 its record investment in India this year of more than $1bn, the largest amount the World Bank's private sector arm has invested in a single country in a single year.
However, Paolo Martelli, the IFC's South Asia director, cautioned that the broader investment climate for private equity firms in India was becoming more challenging as a flood of liquidity and enthusiasm over its economic prospects drove up valuations.
"With this big growth and with this increasing liquidity in the market, you see valuations that make you wonder whether they really reflect the fundamentals," Mr Martelli told the Financial Times.
India has become a focus of private equity firms with deals worth more than $5.9bn this year, 50 per cent more than the total for all last year. Most of the leading firms have set up in India or are finalising plans to do so.
The IFC has been one of the most active investors, providing debt and equity to projects ranging from a power plant being built by the Tata group to funding for a small private sector bank, the South Indian Bank, in Kerala state.
Mr Martelli said the IFC would channel up to 50 per cent of its investments in India into infrastructure this fiscal year ending June 2008 and would also seek opportunities in affordable housing and financial institutions.
But there was a growing "disconnect" between the market's ability to distinguish between the broad themes of India's strong economic growth and favourable demographics, and the prospects of individual companies. This was driving up valuations for private equity firms.
"The private equity industry in India is on a strange path," Mr Martelli said.
"The principle of private equity is to have a good entry price, work out with the company a management, grow it, make it more efficient, increase the underlying value, then sell. [But] if the entry price is huge . . . you need to work very hard."
His comments follow a recent survey by Deloitte Corporate Finance Services India which found that the majority of the private equity firms expected returns in India to fall over the next six months.
Michael Klein, IFC chief economist, said the country continued to be popularwith investors in spite of coming 120th in the IFC's Doing Business study, well behind neighbours such as Sri Lanka, Bangladesh and Pakistan.