Nicosia: Cyprus is highly exposed to geopolitical shocks emanating from the Middle East due to the significant roles of tourism and shipping in its economy, as reported by Morningstar DBRS. Despite recent resilient growth, the effective shutdown of the Strait of Hormuz and disruptions in airspace are compelling shipping rerouting, incurring higher costs, and putting upward pressure on freight rates. These factors are adversely impacting air travel and tourism demand, with Cyprus being particularly vulnerable due to its geographic proximity to conflict areas.
According to Cyprus News Agency, the rating agency has highlighted the exposure of Cypriot banks to tourism-related loans. However, the banking sector maintains robust profitability and capital buffers, which could help it navigate the challenging operating environment. The high importance of tourism for Cyprus' economy is underscored by the large share of hotels and restaurants in the country's total gross value added (GVA). Apart from these sectors, tourism impacts various service industries like transportation and entertainment and has substantial indirect effects on macroeconomic developments, especially concerning private consumption.
Shipping also plays a significant role in Cyprus' economy, albeit less pronounced than tourism, but still greater than in most other EU economies. The uncertainty surrounding the Middle East conflict and global oil and gas supplies poses a challenge to Cyprus, with recent events likely to dampen tourism, which has been a major growth driver for the economy in recent years. The Central Bank of Cyprus has adjusted its 2026 real GDP growth forecast, reducing it by 0.3 percentage points to a projected growth rate of 2.7%, based on the expectation of a two-month conflict followed by gradual de-escalation.
Moreover, the blockade of the Strait of Hormuz following U.S. and Israeli strikes on Iran has intensified shipping disruptions. Tankers and container vessels are increasingly rerouting, suspending bookings, and facing higher security and insurance costs. While the closure primarily affects global oil flows, container carriers have diverted to routes around the Cape of Good Hope, reversing earlier expectations of a gradual return to Red Sea routes. Extended voyage distances and elevated fuel consumption are adding upward pressure on freight rates. Additionally, Iran is reportedly levying charges of around USD 2 million per vessel for transit through the Strait of Hormuz, translating to roughly an extra USD 1 per barrel.
The routing via the Cape of Good Hope is likely to remain the medium-term norm due to Red Sea disruptions, with lost volumes from 2024-25 unlikely to recover for eastern and central Mediterranean ports. Limassol in Cyprus has experienced sustained volume losses since 2024, despite ongoing capacity expansion. However, geopolitical risks are expected to have a limited impact on passenger traffic and cruise operators unless they lead to a broader decline in tourism demand or a significant increase in marine fuel costs.
Regarding tourism, DBRS notes that conflict escalation has led to widespread airspace closures across key Gulf countries, disrupting major hubs and forcing airlines to cancel flights, suspend services, or reroute long-haul operations. The disruption affects international travel and tourism through longer flight times, higher fuel burn, and reduced connectivity, increasing costs and affecting passenger demand. Cyprus has seen record-high tourist arrivals in recent years, but for tourism-dependent markets like Cyprus, the spillover effects are most visible in aviation-linked segments, given the high share of visitors arriving by air.
Travel agencies and tour operators may face higher package prices, flight schedule volatility, and margin pressure if costs cannot be fully passed through. While Cyprus is generally viewed as a safe destination, heightened regional tensions have led some travelers to cancel or postpone trips due to safety concerns. The key downside risk for airlines and tourism flows is a sustained increase in fuel prices and operational volatility, which could dampen discretionary travel demand if the conflict persists.
The ongoing Middle East conflict could pose risks for banks in Cyprus through its impact on the shipping and tourism sectors. The rating agency notes that Cyprus' banking system has higher-than-European average exposures to these industries. According to European Banking Authority (EBA) data, the exposure to transport and storage accounted for 11.2% of loans to non-financial corporations (NFC) at 2025, higher than the European average of 5.5%. The sector's exposure to accommodation and food service activities was 21.2% of NFC loans, above the 2.6% European average. Any sustained decline in tourism flows could affect small-medium-sized enterprise performance, household disposable income, and real estate prices, posing asset quality pressure for Cypriot banks.
Early indications suggest that Cyprus is already experiencing a decline in travel demand and high cancellation rates, reflecting heightened risk perception due to its geographic proximity to Middle East conflict areas. However, DBRS points out that asset quality has improved across the sector in recent years and compares favorably with the European average. NPL ratios in transport and storage were close to 0% at 2025 in Cyprus, below the 2.3% EU average, while the NPL ratio in accommodation and food service activities was 0.7% in Cyprus, below the 5% EU average.
According to DBRS, beyond sector-specific channels, the conflict introduces secondary challenges, including elevated energy costs, renewed inflationary pressures, weaker growth prospects, and potential supply-chain disruptions. Monetary policy responses will be crucial, with higher interest rates potentially supporting short-term profitability for Southern European banks but ultimately affecting loan volumes and increasing funding costs and asset quality pressures over the long term. The duration and potential escalation of the Middle East conflict remain key determinants of the credit implications for banks.