The decision to strike South Korea off its so-called “white list” puts fresh trading restrictions on the country.
South Korean President Moon Jae-in on Friday condemned Tokyo’s “selfish” act and threatened possible retaliation.
The trade spat, which includes curbs on tech supplies, has sparked fears over risks to the global electronics sector.
The escalating dispute has been fuelled by diplomatic tensions over compensation for wartime labour.
Japan has said the measures are based on national security concerns, and also address Seoul’s inadequate export controls.
During a televised cabinet meeting, Mr Moon said Tokyo’s “selfish act will inflict tremendous damage on the world economy by disrupting global supply chains”.
“Responsibility for what is going to happen next also lies squarely with the Japanese government.
“Though Japan is an economic powerhouse, if it were to damage our economy, we likewise have countermeasures to implement in kind,” the president said.
South Korea’s ruling Democratic Party also described the moves as “all out declaration of economic war”.