Cyprus is highly exposed to Middle East geopolitical shocks due to the outsized role of tourism and shipping, despite resilient recent growth, Morningstar DBRS says.
The effective shutdown of the Strait of Hormuz and airspace disruptions are driving renewed shipping rerouting, higher costs, and upward pressure on freight rates, while also weighing on air travel and tourism demand, with Cyprus facing comparatively greater vulnerability given its closer geographic proximity to conflict areas, the Canadian ratings agency has reported.
Moreover, according to the rating agency, Cypriot banks are exposed to tourism-related loans. Nonetheless, the sector maintains strong profitability and capital buffers which will help navigate a riskier operating environment.
The importance of tourism and shipping
The high importance of tourism for Cyprus' economy is exemplified by comparatively large share of hotels and restaurants at total gross value added (GVA), DBRS notes. Apart from hotels and restaurants, tourism also affects several other service industries, such as transportation and entertainment, and has substantial indirect impacts on macroeconomic developments, particularly regarding private consumption, as it employs a large share of the domestic workforce.
Additionally, the importance of shipping, while less pronounced than tourism, still plays a much larger role than in most other EU economies.
While uncertainty on the future evolution of the Middle East conflict and global oil and gas supplies is currently high, recent events are likely to dampen tourism which had been a major growth driver for Cyprus' economy in recent years.
DBRS quotes the recently published macroeconomic projections by the Central Bank of Cyprus cut the 2026 real GDP growth forecast by 0.3 percentage points to a still strong growth rate of 2.7%. This is based on the expectation that the conflict will last two months and will be followed by a gradual de-escalation thereafter.
Moreover, it adds that the effective blockade of the Strait of Hormuz following U.S. and Israeli strikes on Iran has intensified shipping disruptions, with tankers and container vessels increasingly rerouting, suspending bookings, and incurring higher security and insurance costs. While the closure primarily affects global oil flows, container carriers operating in the Gulf have again diverted around the Cape of Good Hope, reversing earlier expectations of a gradual return to Red Sea routes and higher fleet capacity that had contributed to ease freight rates and weaken 2026 earnings outlook.
However, extended voyage distances, elevated fuel consumption, and rising war-risk premiums are putting upward pressure on freight rates. Moreover, Iran has reportedly begun informally levying charges of around USD 2 million per vessel for transit through the Strait of Hormuz, equivalent to roughly extra USD 1 per barrel.
With Cape of Good Hope routing likely to remain the medium-term norm because of Red Sea disruptions, lost volumes from 2024-25 are unlikely to recover for eastern and central Mediterranean ports. According to the rating agency, Limassol in Cyprus has experienced sustained volume losses since 2024 despite ongoing capacity expansion.
On the other hand, it notes that geopolitical risks are expected to have a limited impact on passenger traffic and cruise operators unless they feed into a broader deterioration in tourism demand or marine fuel costs increase materially.
Regarding tourism, Morningstar DBRS notes that the conflict escalation has triggered 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 has broader implications for international travel and tourism through longer flight times, higher fuel burn, and reduced connectivity, which raise costs and weigh on passenger demand.
Cyprus has experienced record-high tourist arrivals in recent years. However, for tourism-dependent markets such as Cyprus, the spillover effects are most visible through aviation-linked segments, given the high share of visitors arriving by air from Western Europe and long-haul source markets. Arrivals in Cyprus appear to be quite diversified by country. However, DBRS notes that Cyprus shows higher dependence on Israeli visitors which could add further pressure due to closed airspace and cancelled flights.
Travel agencies and tour operators could face higher package prices, flight schedule volatility, and potential margin pressure where costs cannot be fully passed through. It is noted that, while Cyprus is generally viewed as a safe destination, heightened regional tensions have led some travellers to cancel or postpone trips due to safety concerns. At the same time, the key downside risk for airlines and, by extension, tourism flows remain a sustained increase in fuel prices and operational volatility, which could dampen discretionary travel demand if the conflict persists.
Effects on the banking sector
The ongoing Middle East conflict could add risks for banks in Cyprus through its impact on the shipping and tourism sectors, with the rating agency noting that Cyprus' banking system holds higher-than-European average exposures to these industries.
According to the European Banking Authority (EBA) data, exposure to transport and storage accounted for 11.2% of loans to non-financial corporations (NFC) Cypriot banks at 2025, higher than European average which stood at 5.5%. At the same time, the sector’s exposure to accommodation and food service activities represented 21.2% of NFC loans at 2025, above the 2.6% European average. Therefore, any sustained decline in tourism flows would transmit through small-medium-sized enterprise performance, household disposable income, and real estate prices, posing more immediate asset quality pressure for Cypriot banks.
Early indications suggest that Cyprus is already experiencing pronounced decline in travel demand and high cancellation rates, reflecting heightened risk perception due to its geographic proximity to Middle East conflict areas, the rating agency says.
However, DBRS points out that asset quality has improved across the sector in recent years and compares favourably with European average. NPL ratios in transport and storage stood close to 0% at 2025 in Cyprus, below 2.3% EU average, whereas NPL ratio in accommodation and food service activities was 0.7% in Cyprus, below 5% EU average.
According to DBRS, beyond sector-specific channels, the conflict introduces second-round headwinds, including elevated energy costs, renewed inflationary pressures, weaker growth prospects, and potential supply-chain disruptions. Monetary policy responses will be a key variable, it notes. While higher interest rates to counter rising inflation could support profitability for Southern European banks in the short run, consistent with experience in the 2022-24 tightening cycle, they would ultimately affect loan volumes while increasing funding costs and asset quality pressures over a longer horizon.
In any case, the rating agency highlights that the duration and potential escalation of the Middle East conflict remain key determinants of the ultimate credit implications for banks.
Also read: Morningstar DBRS upgrades forecast for Cyprus' growth to 3% for 2026 and 2.6% for 2027
(Source: CNA)
