Last Updated at 15 Mar 2011, 06:45 GMT 
The Nikkei 225 shed 10.6% to 8,605, and the broader Topix index fell 9.5%.
Europe markets opened 1-2% lower amid concerns over the negative impact on global sentiment, as well as possible disruption to manufacturers' supply chains from Japanese parts makers.
Among the worst hit European stocks were consumer goods, led by carmakers such as Volkswagen (down 4.6%), and utilities active in nuclear energy such as E.On (down 4.9%).
'Pulling out' Japan was hit by a massive earthquake and tsunami on Friday, causing billions of dollars of damage.
Following the latest explosion at the Fukushima plant, the Nikkei was down 14% at one point on Tuesday, registering its biggest two-day drop in 40 years.
The BBC's Chris Hogg in Tokyo said that Japan's nuclear safety agency suspects the explosion may have damaged the vessel that holds the number two reactor.
That would make it a more serious incident than the two previous explosions at Fukushima that were thought just to have damaged the buildings that housed the reactors, he said.
Hideyuki Ishiguro of Okasan Securities in Tokyo said: "All focus is on the nuclear crisis.
"In the situation where the crisis appears to be worsening, foreign investors, domestic fund operators, are pulling out from Japanese shares," he added.
Taiwan stocks finished down 3.4%, their biggest drop in 13 months.
Currency issues The devastation is also affecting the price of the Japanese currency.
The yen is gaining in strength as Japanese firms, including insurance companies, buy back their home currency in order to fund the country's reconstruction.
The Japanese currency strengthened to 81.40 yen against the US dollar before settling back to near 81.65.
A stronger yen is detrimental for the export-dependent economy as it not only makes its products more expensive, but also eats into the profits of Japanese companies when they repatriate their foreign earnings back home.
Japan's finance minister said on Tuesday that he would monitor currency market moves.
Explosions at the Fukushima nuclear reactor have raised concerns about disruptions in energy supply However, Yoshihiko Noda would not confirm or deny that there had been intervention in the currency market.
"We will continue to monitor the market," Mr Noda said.
Analysts said there were signs that the central bank may have intervened in the market after the US dollar strengthened suddenly on Tuesday.
Economic impact Concerns about the impact of the devastation on Japan's economy have been rising as the extent of devastation becomes clear.
The blasts at the nuclear plant and the threat of a radiation leak has further escalated those fears.
A nuclear disaster will escalate the cost of rebuilding and reconstruction many fold.
According to some estimates, the devastation caused by Friday's deadly earthquake and subsequent tsunami is expected to cost Japan $180bn (£111bn) in reconstruction and recovery.
That is 50% higher than the cost of rebuilding after the 1995 earthquake in Kobe.
There are concerns that the increasing cost of rebuilding will add further to Japan's debt levels.
Japan has the highest public-debt levels in the industrialised world.
Last month, the country's debt rating was downgraded on concerns that it was not doing enough to address the issue.
At the same time, analysts have forecast that the quake could knock off as much as one percentage point from Japan's gross domestic product.
Japanese shares have plunged on escalating fears of a radiation leak at the Fukushima Daiichi nuclear plant.
There have been reports of a fire and explosion at the plant, raising concerns of a meltdown. The Nikkei 225 shed 10.6% to 8,605, and the broader Topix index fell 9.5%.
Europe markets opened 1-2% lower amid concerns over the negative impact on global sentiment, as well as possible disruption to manufacturers' supply chains from Japanese parts makers.
Among the worst hit European stocks were consumer goods, led by carmakers such as Volkswagen (down 4.6%), and utilities active in nuclear energy such as E.On (down 4.9%).
'Pulling out' Japan was hit by a massive earthquake and tsunami on Friday, causing billions of dollars of damage.
Following the latest explosion at the Fukushima plant, the Nikkei was down 14% at one point on Tuesday, registering its biggest two-day drop in 40 years.
In a nationally televised statement, Prime Minister Naoto Kan said that radiation levels at the plant were running high.
"The level seems very high, and there is still a very high risk of more radiation coming out," Mr Kan said. The BBC's Chris Hogg in Tokyo said that Japan's nuclear safety agency suspects the explosion may have damaged the vessel that holds the number two reactor.
That would make it a more serious incident than the two previous explosions at Fukushima that were thought just to have damaged the buildings that housed the reactors, he said.
Hideyuki Ishiguro of Okasan Securities in Tokyo said: "All focus is on the nuclear crisis.
"In the situation where the crisis appears to be worsening, foreign investors, domestic fund operators, are pulling out from Japanese shares," he added.
End Quote Yoshihiko Noda Japan's Finance MinisterWe will continue to monitor the market”
Japanese shares were not the only ones to fall as markets across the region slid.
Australian shares fell 2.1% to their lowest close in over six months, while Korea's main Kospi index ended the day 2.4% lower.Taiwan stocks finished down 3.4%, their biggest drop in 13 months.
Currency issues The devastation is also affecting the price of the Japanese currency.
The yen is gaining in strength as Japanese firms, including insurance companies, buy back their home currency in order to fund the country's reconstruction.
The Japanese currency strengthened to 81.40 yen against the US dollar before settling back to near 81.65.
A stronger yen is detrimental for the export-dependent economy as it not only makes its products more expensive, but also eats into the profits of Japanese companies when they repatriate their foreign earnings back home.
Japan's finance minister said on Tuesday that he would monitor currency market moves.
Explosions at the Fukushima nuclear reactor have raised concerns about disruptions in energy supply "We will continue to monitor the market," Mr Noda said.
Analysts said there were signs that the central bank may have intervened in the market after the US dollar strengthened suddenly on Tuesday.
Economic impact Concerns about the impact of the devastation on Japan's economy have been rising as the extent of devastation becomes clear.
The blasts at the nuclear plant and the threat of a radiation leak has further escalated those fears.
A nuclear disaster will escalate the cost of rebuilding and reconstruction many fold.
Power industry expert Benjamin Sovacool tells Asia Business Report that nuclear power is too expensive
That is 50% higher than the cost of rebuilding after the 1995 earthquake in Kobe.
There are concerns that the increasing cost of rebuilding will add further to Japan's debt levels.
Japan has the highest public-debt levels in the industrialised world.
Last month, the country's debt rating was downgraded on concerns that it was not doing enough to address the issue.
At the same time, analysts have forecast that the quake could knock off as much as one percentage point from Japan's gross domestic product.
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