The global investment community is known for its manic mood swings, but even by that standard its rediscovered love for India is neck-snapping. Cast as a submerging nation a year ago, the country is now the toast of the fast money crowd. This year they’ve poured more money into India than into any other emerging country, and have helped to make Mumbai one of the hottest stock markets in the world, with a gain of nearly 30%.No other developing country has undergone this kind of image upheaval. India has morphed in the eyes of the world from a star to a dud to a star again, and all within the last five years. For now, however, there are good reasons why India seems to be everyone’s favourite emerging nation.It is the only big one that has stopped disappointing its international suitors. The consensus GDP growth forecast for 2015 has been falling steadily for other large emerging markets, but is ticking higher for India. One big factor is the fall in prices for oil and other commodities, which has sent commodity-exporting economies like Brazil and Russia into recession, but is a boost for a big energy importer like India.Better yet, low oil prices help take the edge off of inflation in India, now one of the very few nations enjoying the auspicious combination of increasing growth and falling inflation. The current account deficit too has declined from 5% of GDP in 2013 to about 2% this year in India, even as it deteriorates elsewhere. The rupee has lost 6% of its value against the surging dollar, but other currencies at the heart of the 2013 scare have fallen harder since then, by 15% on average. Investment has yet to pick up in India, but investment is flat to flailing everywhere else, too.India is also the only emerging nation that has delivered on hopes for new leadership. Six big developing countries held pivotal national elections this year, and global markets were eagerly anticipating the victory of reform-minded leaders, especially in Brazil, Indonesia and India. As it happened, only Narendra Modi won with a clear mandate.Elsewhere in the emerging world, politics has lost its economic promise. Russia and Turkey remain under the control of aging autocrats with waning interest in reform. China’s leaders seem hobbled by the unmanageable debt burden that is dragging down its growth rate. Mexican President Pena Nieto’s big-bang attack on monopolies has generated surprisingly little pop for economic growth and his popularity ratings are declining.In Brazil, the markets were rooting for the defeat of Workers Party President Dilma Rousseff, but she narrowly won last month. High hopes for President Joko Widodo of Indonesia are fading, with the realisation that he lacks the parliamentary backing to push real change. Drop all these disappointments, and only Modi survives as a potential reformer who has the clout to get things done. Though some critics say Modi has so far made only painless changes, his recent call for a “trans-formative” budget in 2015 has global investors assuming that the big-bang reform is on its way.So why wouldn’t everyone embrace India? The hype is itself a worrying sign. The risk is that the country will start believing its own reviews, and get complacent all over again. India has a long record of abandoning reform when the future looks bright, which helps explain why in recent decades — including the post-1991 liberalisation era — there has never been any five-year period when it has grown more than a point or two faster than the emerging world average, even though it should be relatively easy to grow fast from India’s low base.With the annual growth rate of emerging economies likely to average around 4% for the rest of this decade, India will have to break out of its normal path if it wants to achieve a growth rate of 7-8%.Commentators have offered Modi a laundry list of reforms that could produce stronger growth, but if there is one silver bullet it is banking sector reform. Right now, investment is growing weakly in large part because credit is growing at about half the 15-20% rate needed to generate and sustain a faster economic growth rate. To deliver on his call for “transformative” change, Modi needs to unclog bottlenecks slowing the flow of credit.Unfortunately, there are some signs his administration wants to boost growth by pressuring the Reserve Bank of India into cutting interest rates, an approach that failed under the last government. RBI should be left free to focus on fighting inflation — a focus that may lead to lower rates anyway, now that inflation is falling. Even those who want to use RBI as a state tool to pump up growth should be wary, because cutting interest rates won’t provide much of a boost if the new lending is dispensed by the same old banking system.Fixing the banks is thus the biggest test of Modi’s seriousness as a reformer. Roughly 70% of Indian bank loans are dispensed by government-owned banks and after years of mismanagement they lack the capital to significantly increase lending, with estimates of the capital shortfall running around $40 billion, over the next five years. But the government doesn’t have $40 billion to recapitalise the banks.One fix is to attract some foreigners to invest in state banks by changing the way those banks are governed — for example, separating the roles of CEO and chairman to improve oversight. But investors won’t flock to buy partial stakes in a marginally improved state bank, so that measure is unlikely to raise the requisite sum. Another option is cutting welfare spending to fund bank recapitalisation, but in India that idea would be shouted down as stealing from the poor to save the banks.The final option is possibly more controversial, politically, but it is the only one likely to yield a meaningful boost to growth. That would be to sell the state banks to the private sector. Due to sloppy lending, about 12% of state bank loans have gone bad and have been mostly “restructured”, meaning the borrowers haven’t made payments in months. The comparable figure for private banks is around 4% — a strikingly low number given the tough conditions of recent years, and testimony to the superior efficiency of the private sector.Since the end of 2010, when the Indian economy started to lose momentum, the value of shares in private banks has risen sharply, generating $33 billion in new wealth, while the state banks have destroyed $27 billion. This is the market’s way of pointing out which Indian banks work well, and which don’t. In the past, when India was this hot in the world’s eyes, Indian policymakers have tended to ask, “Where else will the money go?” By now they should know how fickle the world can be. To hold on to its favourite country status, the Modi government should seize the moment before its political capital decays. It could keep minority stakes or some other form of influence over state banks, but it needs to sell off its majority stakes and change the character of the banking system in India.Lately most of the foreigners coming into India have been buying stocks, bonds and other portfolio investments but the country needs to broaden its capital base. Cleaning up the banks could attract more long-term capital, which could speed up GDP growth by unleashing a fresh credit cycle, helping to fund a new wave of entrepreneurs. And it could, finally, justify the world’s love for more than a fleeting season.The writer is head of emerging markets and global macro at Morgan Stanley Investment Management.