BEIJING (Reuters) - The World Bank cut its economic growth forecast for China this year to 8.2 percent on Wednesday and urged the country to rely on easier fiscal policy that boosts consumption rather than state investment to lift activity.
In a biannual East Asia and Pacific economic update, the World Bank said a slowing China will drag growth in emerging East Asia to two-year lows this year, but warned Europe's seething debt crisis could inflict even bigger damage if it worsens.
Sluggish U.S. and European demand and a softening Chinese property market would combine to weigh on the Chinese economy in the near term, it said.
But if governments and central banks act in time to stabilize activity, economies should recover next year.
It said countries could further loosen monetary and fiscal policies to foster activity, but noted their room for maneuver is constrained by inflation risks that could spike when growth rebounds amid rising public debt now.
"The region's authorities should remain flexible to shift monetary policy gears should growth gain traction and inflationary pressures build up," the World Bank said.
In China, where 2012 economic growth was lowered to 8.2 percent from 8.4 percent previously, it said Beijing should only marginally tweak monetary policy for now by lowering banks' reserve requirements as real interest rates are negative.
That leaves the world's No. 2 economy to lean on fiscal policy instead to fuel growth.
"Fiscal stimulus would ideally be less credit-fuelled, less local government-funded, and less infrastructure-oriented," the World Bank said.
"Fiscal measures to support consumption, such as targeted tax cuts, social welfare spending and other social expenditures, should be viewed as the first priority."
The World Bank's recommendations come just a day after a top Chinese financial paper cited unnamed sources as saying China will fast track approvals for infrastructure to combat an economic downturn.
The World Bank's lowered growth forecast for this year also comes after the International Monetary Fund kept its forecast for China unchanged at 8.2 percent in its April report.
In a reflection of the World Bank's move to cut its growth forecast in most East Asian countries, it predicted that the region would grow just 7.6 percent this year, down from its previous estimate of 7.8 percent published in November.
And it thought Europe was the biggest threat to growth.
"With the European Union accounting for one-third of global import demand, a recession there will inevitably take its toll on East Asia," the World Bank said.
Its remarks echo those from the OECD this week when the Paris-based body warned that Europe's fiscal woes may scupper a fragile economic revival in the United States and Japan.
Warning that Asia could smart from years of sluggish demand in its mainstay export markets the United States and Europe, the World Bank said regional economies must improve their innovation and productivity if they wish to beat the hard times.
China, the centre of Asia's production networks and which accounted for two-thirds of the region's $592 billion shipments to Europe in 2011, will be the first to suffer from an export slump before passing the effects on to others in Asia, it said.
That European banks provide about a third of trade and project finance in Asia may further stress developing nations during a euro crisis, the bank said, as firms pull investment to repatriate cash back to Europe to meet higher capital ratios.
Making clear that China was second to Europe in dragging on regional activity, the World Bank said growth in East Asian economies would have quickened to 5.2 percent this year from 4.3 percent in 2011 if not for the cooling Chinese economy.
A rebound in the Thai economy as it recovers from last year's heavy floods and Japan's earthquake would underpin growth in emerging East Asia, it said.
Editing by Jacqueline Wong