Japan's fiscal woes also came under the spotlight again after Moody's lowered the outlook for Japanese government debt to "negative" from "stable".

The Nikkei index of the Tokyo Stock Exchange fell 213.15 points to 10,644.38 by the lunch break. The Topix index of all first section shares lost 1.79 percent or 17.46 points to 957.17.

The violent political crisis in oil-rich Libya drove down European shares overnight, pressuring Japanese stocks from the opening bell.

US markets were closed Monday for a national holiday.

Waves of street protests continued in Libya with gunfire rattling the capital Tripoli, where demonstrators attacked police stations and the offices of the state broadcaster and set government buildings ablaze.

"Rising political tensions are making traders risk-averse, and that also creates concerns over possible yen buying," Yumi Nishimura, deputy general manager at Daiwa Securities Capital Markets, told Dow Jones Newswires.

The market felt further pressure after Moody's said it had changed its outlook on the government of Japan's Aa2 rating on concerns that current policy may fail to contain huge debt.

The rating agency said Japan was unlikely to see an immediate crisis but said pressures will grow over the longer term, dealing a fresh blow to Prime Minister Naoto Kan after Standard & Poor's last month lowered its rating for Japan to AA- from AA for similar reasons.

Markets showed muted reaction to the move, since Japan's massive debt problem is widely known and Japanese government bonds are largely owned by domestic investors.

Invest-rust CEO Hiroyuki Fukunaga said Nikkei-225 futures contracts were a likely target for selling after Moody's announcement.

The rating action also pressured Japanese banks, major bond holders.

Mitsubishi UFJ Holdings lost 3.40 percent, while Sumitomo Mitsui Financial Group fell 3.60 percent.

Toyota Motor fell 2.56 percent, Honda Motor dropped 2.45 percent and Sony fell 1.63 percent to 3,025.