The Philippines stock market tried to hold on to a double-digit gain, lagging the regional average, as the finance secretary offered assurance that President Rodrigo Duterte’s martial law declaration on southern Mindanao island would not sway “solid economic fundamentals” after first-quarter GDP growth slowed to 6.4%, still the fastest in Southeast Asia. Political risks have dominated since the president took office a year ago, and spats with the US and China over alliances and territorial claims and with the UN over human rights abuses related to drug dealer killings had experienced a lull before the Murawi siege by reported Islamic State sympathizers. Investors who had looked the other way with his combative leadership, both literally and figuratively, especially since popular approval remains high, now worry about the costs of the continuing anti-drug and anti-terror campaigns, and whether the archipelago will become a new staging ground for IS incursions throughout the region. Doubts have also surfaced about underlying economic stability with the central bank warning of credit overheating and the first current account deficit in 15 years, as these setbacks overshadow infrastructure spending and tax reform plans.

Analysts have begun to hedge their bets on another year of 6.5-7% growth, even as consumption is complemented by fixed capital formation up more than 20% last year. Infrastructure project imports are expected to swell the trade deficit, with the balance of payments projected to be in a $500 million hole this year despite steady foreign direct investment and remittance inflows, which could again send the peso below 50 to the dollar. International reserves are estimated to fall to $80 billion by year-end compared to the original $85-billion target, and external borrowing is manageable at 25% of output, but public debt overall has risen toward 45%. Inflation is currently above 3% versus sub-2% in 2016, due to food prices but also near 20% annual credit expansion, concentrated in real estate, manufacturing and information technology. Central bank chief Nestor Espenilla claimed he was “not complacent” about the boom and acknowledged these businesses could face difficulty with “cyclical turns.” After a long period on hold, interest rates could be raised at least 50 basis points in the second half if inflationary pressures persist, economists believe. They add that both agriculture and tourism could take hits from the Mindanao fighting and shake commercial and retail confidence.

Moody’s underscored that the agenda redeemed Duterte’s campaign pledges, but added that annual budget gaps would blow out beyond 3% of GDP and imperil debt consolidation without it

The tax reform package, known by the acronym TRAIN, overwhelmingly passed the House in May before Congress adjourned and awaits Senate action. Moody’s Ratings, in maintaining its stable sovereign investment grade, praised the bill for tackling weak revenue generation at 15% of GDP, especially as infrastructure outlays are due to spike to half that ratio. The act will slash income taxes but also loopholes and VAT exemptions while hiking fuel and luxury excise levies. It proposed a complicated five-bracket structure for automobiles, and the final version may include a special soft drink tax to promote health. Moody’s underscored that the agenda redeemed Duterte’s campaign pledges, but added that annual budget gaps would blow out beyond 3% of GDP and imperil debt consolidation without it.

Malaysia too, with mid-range Asian equity performance, has been caught in another round of political drama as US prosecutors move to seize $1.5 billion from alleged 1MDB fund diversions. The saga has implicated Hollywood stars receiving lavish gifts and previous bond underwriter Goldman Sachs, whose lead relationship manager was forced to resign under criminal investigation. Prime Minister Najib Rezak was cleared of misconduct by the domestic legal system and has worked to divert attention to economic success ahead of national elections. GDP growth was 5.5% in the first quarter on good exports and personal consumption, alongside government investment through the high-tech National Transformation Program, which recently introduced additional preferences to favor native Malays. Inflation will be 3-4% this year and the currency has strengthened 4% against the dollar, with traders predicting further appreciation toward 4/dollar now that bond short-selling is allowed. Bank stocks have benefited, with profits up 45% at heavyweight CIMB and another merger between RHB and AMMB in the offing. However, like in the Philippines, official spending may eventually compromise the 3% of GDP fiscal deficit target and help spread a bad loan bonfire with overdone stimulus.