China's trade balance faces the risk of sliding into a deficit for the first time in two decades in 2012 as export demand in Europe and the U.S.slumps, an academic adviser to the central bank said on Tuesday.

China needs a very proactive fiscal policy to spur domestic demand next year amid weakness in Western economies, Xia Bin told Reuters in an interview late on Monday during a visit to Taipei to promote his new book.

But he also said that the world's No.2 economy won't loosen monetary policy, which he said now has about the right tone.

The U.S. economy won't be good next year and Europe will be worse, meaning weak external demand for China. We can't rule out the possibility of a trade deficit, Xia said.

To increase domestic demand, fiscal policy must be very proactive, reform of the tax system should be speeded up and wages raised to stimulate consumption, he added. He didn't give a forecast for any deficit.

Xia, head of the financial research institute at cabinet think tank Development Research Center, sits on the 15-member monetary policy committee of the central bank but doesn't have real influence on key decisions on interest rates or China's yuan currency.

The People's Bank of China has loosened credit conditions recently to help small firms and promised to fine-tune policy if needed to support economic growth, which slowed in the third quarter to 9.1 percent, its weakest in more than two years.

But, barring a sudden and sharp blow to the economy, more aggressive policy easing such as a cut in banks' reserve ratios or interest rates is seen as months away.

Meanwhile, the cash-rich government is flexing its muscles by offering tax cuts to companies.

SLOWER YUAN RISE

Despite faltering Western demand, China's economy is still seen as on track to grow over nine percent this year.

Xia said China expects to maintain economic growth at eight percent to nine percent in 2012 and sees further inflationary pressures, though Beijing will look to keep price rises to two percent to three percent next year.

Annual inflation hit a three-year high of 6.5 percent in July. Though it has eased in recent months, it remains elevated at 5.5 percent.

China's commerce ministry warned last week that the outlook for exports could be grim for the rest of this year and the early part of next, as Europe struggles to contain its debt crisis and the United States seeks to spur its fragile recovery.

China's imports surged 28.7 percent in October while exports grew at 15.9 percent, their slowest rate in months, suggesting Beijing's efforts to tilt the economy toward domestic demand may be offsetting the external weakness that has dragged on economic growth this year. That capped October's trade surplus at $17 billion.

The government expects the full-year trade surplus to narrow to around $150 billion in 2011 from last year's $183 billion, the third straight year of decline.

Despite the global gloom, Xia's view of a possible trade deficit remains a minority one.

Last month, Wei Jianguo, a former vice commerce minister and secretary general of think-tank the China Center for International Economic Exchanges, also raised the possibility.

However, most economists say that while there is little doubt the trade surplus will continue to narrow, it might take a few more years for China to see a full-year trade deficit, unless exports collapse.

Also, there may be limited room for the government to spur domestic demand as economic growth slows.

The massive trade surplus has long been a source of friction with the U.S. and China's other major trading partners, many of whom complain that Beijing keeps its yuan currency undervalued to boost exports.

But U.S. trade and employment problems would not be solved by even a major appreciation of China's yuan versus the dollar, Chinese President Hu Jintao was quoted as saying last week.

The yuan has gained about 40 percent in real effective exchange terms since Beijing abandoned its peg to the U.S. dollar in 2005, and has rallied almost four percent against the dollar in nominal terms this year.

On the growing internationalization of China's yuan currency, Xia said that by 2020 the yuan will make up about three percent to five percent of the world's reserve currencies. But he saw the process only happening slowly.

(Additional reporting by Kevin Yao in BEIJING; Writing by Jonathan Standing; Editing by Jacqueline Wong & Kim Coghill)