Japan's economy could shrink after a devastating earthquake and tsunami earlier this month, but the government has the fiscal and credit means to deal with a disaster which could cost twice as much as the 1995 Kobe earthquake, ratings agency Moody's said on Monday.

Moody's said the downside risks from the disaster have increased over the past week for the world's third-largest economy and its sovereign credit.

Japan, which has public debt twice the size of its $5 trillion economy, is rated Aa2 by Moody's.

"If the Japanese government falters in its efforts to contain the spread of radiation from Fukushima, a large drop in consumer confidence could ensue, with negative repercussions for the country's economy," Thomas Byrne, Moody's senior vice president in Singapore, said in a report.

Japan's economy contracted an annualised 1.3 percent in the fourth quarter, but had been showing some signs of recovering early this year before the March 11 quake struck.

"If coupled with power shortages that create an extended delay of a resumption of production to pre-disaster levels, the country's full-year gross domestic product could contract... However, the Japanese government has the fiscal wherewithal and creditworthiness to deal with a disaster that could cost twice as much as the Kobe earthquake of 1995," he said.

Japan suffered an estimated $250 billion in damage from the earthquake and tsunami which left more than 21,000 people dead or missing, while radiation leaks from the Fukushima nuclear plant have caused global alarm. Many factories and homes in the area are still without power.

Moody's said its base-case assumptions remain broadly unchanged from a week ago, expecting that Japan's economy would start to grow again in the second half of next year, thanks in part to reconstruction efforts.

It also said it expected investors would remain confident in Japanese bonds.

Last week, Moody's said no fiscal crisis was imminent in Japan after the earthquake as debt markets were likely to fund government deficits. However, it said a tipping point may be reached if the market loses confidence in the soundness of government finances.

* For more news on the Japan disaster, see (Reporting by Natsuko Waki; Editing by Kim Coghill)