By Anna Yukhananov
WASHINGTON (Reuters) - Japan's economy contracted in the second half of 2012 and is on track for lackluster growth of 0.8 percent this year, hurt in part by a territorial row with China, the World Bank said in a report on Tuesday.
Relations between China and Japan, the world's biggest economies after the United States, have deteriorated sharply since September, when the Japanese government purchased islands that China claims in the East China Sea.
The value of Japanese exports to China fell by 17 percent between June and November of last year, contributing to a 3.5 percent annualized drop in Japan's growth in the third quarter.
The World Bank said the end of government tax incentives to purchase fuel-efficient automobiles also hurt the economy, as well as the fading boost to growth from reconstruction spending in the aftermath of the 2011 earthquake and nuclear disaster.
"In Japan, the economy appears to be contracting -- in part because of political tension with China over the sovereignty of islands in the region," it said in its twice-yearly Global Economic Prospects report.
Revised GDP figures released by Japan in December showed the Japanese economy contracted in both the second and third quarters, and analysts expect it shrank further in the final three months of the year, as does the World Bank.
The Washington-based global development lender said its forecast for 2013 assumed an improvement in Tokyo's relations with China. Assuming that, Japan would be on track to achieve growth rates of 1.2 percent in 2014 and 1.5 percent in 2015.
While it warned that weakness in Japan could pinch global trade, given that Japan is the world's fourth-largest importer, it said a resolution of Sino-Japanese tensions could help speed a return to growth in Japan and boost the global recovery.
A slowdown in China due to a sudden unwinding of its high investment rate could also sting global growth. In addition, it would push down commodity prices, as China consumes a large portion of the world's metals and oil.
However, the World Bank said this scenario of a hard economic landing is unlikely and it reiterated its forecast released in December that China's economy would expand 8.4 percent this year.
The Bank expects growth in the world's most populous nation to slow to around 8 percent in 2014, with the potential pace of economic expansion declining as productivity and labor force growth taper off.
As China starts to slow down in the medium-term, India's economy should pick up. The South Asian economy was marred by electricity shutdowns, a subpar harvest, and a drop in imports to Europe, leading to growth of only 5.1 percent in the fiscal year ending in March, the weakest rate in nearly a decade.
But starting from this year, the economy should accelerate, as the government loosens restrictions on foreign direct investment and reforms other policies, the Bank said.
The World Bank expects India to grow 6.6 percent in 2014, and 6.9 percent by 2016, narrowing the gap with China, which is expected to grow 7.9 percent that year.
World Bank chief economist Kaushik Basu said China has grown at around 10 percent for close to three decades, an unsustainable rate in the long term, while India only took off about a decade ago and still has room to grow.
"Who knows, a couple of years down the road they may be neck to neck," he told reporters.
(Additional reporting by Lesley Wroughton; Editing by M.D. Golan and David Brunnstrom)