By Doron Levin, contributor
FORTUNE — The dispute between China and Japan over a few small islands in the East China Sea is wreaking havoc on Japanese automakers selling vehicles in China. The row has provided an unexpected dividend to non-Japanese competitors, notably Hyundai, South Korea’s largest automaker.
Toyota (TM), Honda (HMC) and Nissan (NSANY) have each announced negative impacts to financial results or vehicle production schedules as many Chinese consumers boycott their brands. Hyundai, meanwhile, said third-quarter profit rose 13% as vehicle sales in China surged 19% in the period. From July through September, sales of Japanese cars dropped a staggering 41% in China.
Japan’s auto industry is “the pearl in the crown” of the nation’s economy. China “will not rule out the possibility of continuing to squeeze Japanese companies in order to hit the Japanese economy” as a result of the dispute, according to an October report of LMC Automotive Ltd., a consultancy.
Protests in China broke out in September after Japan announced it was buying what it calls the Senkaku Islands (or Diaoyu in Chinese) from private owners, thus changing the status quo and infuriating the Chinese government. The islands, whose ownership was disputed, had been awarded to Japan by the U.S. in 1972. Until Japan’s latest move, China more or less acceded to Japan’s supervision of the area.
In an interview published Oct. 31 in the Financial Times, Carlos Ghosn, CEO of Nissan, said a breakdown in relations between Japan and China could slow Nissan’s aggressive expansion plans. He said a factory in Dalian, China scheduled for construction in 2014 remains on track. But further investments will be viewed cautiously. Nissan sales in China were off 35% in September; he said the automaker may not achieve its annual sales goal for the fiscal year ended in March.
Earlier in the week Honda, whose China sales were down 40%, lowered its profit forecast, based on the consumer boycott of its vehicles.
Tim Dunne, an analyst with LMC Automotive, said “it’s hard to know how long the protests will continue” in China. The historical context of the disputed islands “happened so long ago, many people wouldn’t be aware of it if it hadn’t been put on TV. It feeds upon itself,” he said.
Japanese automakers have been struggling with remarkable bad fortune, having suffered from natural disaster in their own country, floods in Thailand — and in the case of Toyota, an uproar over product quality in the U.S. that proved to be largely unfounded.
The anger by Chinese consumers against Japanese cars recalls a popular backlash in the U.S. in the 1980s against Japanese imports, which helped accelerate the opening of Japanese factories and suppliers across North America.
According to LMC Automotive, Japanese luxury brands Lexus, Acura and Infiniti will struggle as BMW and Audi pick up the slack. But the Japanese have an advantage in the sport-utility vehicle market, with the Europeans not offering much in the way of competition.
China has lately been stepping up its maritime patrols around the disputed islands, while amping up diplomatic rhetoric, suggesting that conditions may not soon improve for Japanese automakers. In that case, Honda, Toyota and Nissan may have to look elsewhere to expand — the U.S., Russia, Brazil or possibly in developing nations. No Japanese automaker can afford to pull the plug on China’s auto market, the fastest-growing in the world– and now the most volatile.