TOKYO - China says Japan must take "full responsibility" for any losses in bilateral trade resulting from a dispute over several uninhabited East China Sea islets that saw anti-Japanese protests flare up in many cities.
While the demonstrations have largely subsided, Japanese companies are reportedly reviewing their investments in China, especially after blue-chip firms like Panasonic and Canon saw their plants damaged at the weekend.
There are currently more than 22,000 Japanese companies in China, creating jobs for some 10million Chinese workers.
The protests were sparked by Japan's nationalisation last week of three of the isles, which the Japanese call Senkaku. These are also claimed by China, which refers to them as the Diaoyu islands.
"It will inevitably affect China-Japan trade ties and harm normal development," China's Commerce Ministry spokesman, Mr Shen Danyang, told a press briefing in Beijing yesterday, hinting at possible economic sanctions.
A commentary in the People's Daily on Tuesday had suggested that China could take a multi- pronged approach on sanctions, targeting such sectors as manufacturing, finance and investments.
Mr Shen said China did not wish to see trade ties worsen between the two countries.
"Japan must take full responsibility for this," he added.
He also warned that the current dispute was likely to affect trilateral free trade negotiations involving China, Japan and South Korea that are supposed to start before the end of the year.
China is now Japan's largest trading partner, with bilateral trade accounting for some 20 per cent of Japan's total trade.
But clamping down on trade with Japan could be a two-edged sword.
Japan exports mainly semi-finished components, chemicals and manufacturing equipment to China, particularly for use in making cars and electronic goods.
As it is difficult to find alternative suppliers for many of these products, restricting Japanese imports would affect China's own manufacturing industries and even threaten Chinese jobs.
There have been widespread calls for a boycott of Japanese- made products in China.
Sales of Japanese cars had begun falling even before the latest round of demonstrations, likely as a result of a previous flare-up in tensions in 2010 after Japan arrested a Chinese trawler captain for ramming his boat against a coast guard vessel near the Senkakus.
In 2010, Japanese cars had a 23.5 per cent share of the Chinese market. This dropped to 22.7 per cent last year and then to 22.3 per cent for the first half of 2012.
In the wake of the latest troubles, Chinese who booked Japanese cars have reportedly asked dealers to delay delivery of their vehicles.
Arson attacks damaged several Toyota, Nissan and Honda dealerships in Qingdao, and dozens of cars were set on fire in the weekend protests.
"The unprecedented torching of Japanese plants and car dealerships is a big shock to Japanese companies," said Mr Hidehiko Mukoyama, senior economist at the Japan Research Institute.
"Japanese companies are reminded of the political risk of doing business in China. The latest episode will hasten the transfer of industries from China that are labour-intensive," he added.
Rising wages in China and the appreciating yuan have already prompted many Japanese companies to look for new production sites in South-east Asia.
Only companies that find the huge Chinese market attractive will find it difficult to move out of China, said Mr Mukoyama.
But he said that for the medium-term, Japanese companies could be expected to review the scale of their investments in China, as well as the scale of retail operations in the country.
Mr Shoei Utsuda, chairman of the Foreign Trade Council, which groups Japan's largest trading companies, said: "In such a situation, we have to be careful about investing in China."
In 2010, China retaliated against the trawler captain's arrest by cutting exports of rare earth metals to Japan and delaying customs clearance for Japanese imports to China.
Mr Utsuda warned: "We have to assume it could happen again."