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China will probably stimulate its economy next year, shielding Latin American commodities producers from Europe's debt crisis by underpinning demand for raw materials, Nobel Prize-winning economist Joseph Stiglitz said.

While China can be counted on to use its massive reserves to try to keep its economy from faltering, it is Europe's austere response to its own financial mess that poses the bigger threat to Latin America, the former World Bank chief economist told Reuters in an interview.

The region will not only see cuts in exports to Europe, but reduced lending by Spanish banks. Spain's banks have a strong presence in South America and their local units may be forced to send money back home next year as hard times continue in Europe.

Spain's Santander has big operations in Brazil, Latin America's No. 1 economy. It is also Chile's top bank.

“Europe is going into a recession, and that will hurt demand. So the damage to Chile will be mostly through trade. And then there is the finance channel,” said Stiglitz, who is known for his view that governments should spend in times of crisis.

“It's hard not to see those Spanish banks operating in Chile going through a contraction. That will require very careful management of the credit supply,” Stiglitz said over a plate of ravioli at a restaurant in Santiago, Chile, where he was travelling after attending a conference in neighbouring Argentina.

Since before 2008, when the bursting of the US housing bubble sent financial shockwaves around the world, setting the stage for Europe's meltdown, Latin America has enjoyed strong economic growth fuelled in part by China's insatiable appetite for commodities.

But that is expected to change next year as signs emerge of a slowdown in China while Europe gropes for a solution to its over-indebtedness.

China and Europe are top trade partners for commodities-producing countries such as grains-rich Argentina and Brazil, oil-rich Venezuela and copper-producing powerhouse Chile.

Of Chile's $61.9 billion in exports from January through September, for example, 21 percent went to China and 19 percent to Europe.

Germany is meanwhile leading a push for belt tightening and automatic sanctions for European deficit sinners.

“The shared austerity in Europe is going to lead to slower growth,” Stiglitz said.

“The financial markets are going to get disappointed because tax revenues are going to be lower. Once people figure this out they're going to demand higher interest rates and then they'll realise that the solution didn't work,” he added.

China, on the other hand, has the resources, the instruments and the political will to use them to ensure its economy does not have a hard landing, the economist said.

“They're sitting on $3 trillion in reserves. And when they tell their banks to lend, they lend,” said the Indiana born and now New York-based Stiglitz.

“If the Chinese economy needs stimulation, they have the resources and the political will to do it. Also, unlike the United States, they don't have half the country committed to an ideology which says the way to solve the problem is to cut spending,” he said. “If their economy slows, they'll spend to keep going.”

Recent data from Beijing showed the first year-on-year drop in foreign direct investment in 28 months.

The Chinese government vows that economic growth will continue despite an “extremely grim” 2012 world outlook.

Stiglitz said that China may increase public housing programs as part of its counter-cyclical policies. This could help prop up demand for Chilean copper, which is used for wiring new houses in for making electronic goods.

Chile is the world's biggest producer of the metal and China is its top client. So Chile and its neighbours will “almost surely” get caught in the global doldrums next year, pushing policymakers to free up money supplies, Stiglitz said.

Brazil has plenty of room to lower interest rates to bolster its economy in the face of global weakness, President

Dilma Rousseff said on Friday.

Chile has already seen signs of economic sluggishness and while Tuesday's central bank decision to keep its base interest rate at 5.25 percent came as no surprise, analysts expect the

bank to slash the rate by a full percentage point during 2012. “It's going to be a very precarious time for the global economy,” Stiglitz said. - Reuters