An escalation of Europe's debt crisis could slash China's economic growth in half this year, the International Monetary Fund said Monday, urging Beijing to prepare stimulus measures in response.

The IMF, in an economic outlook report on the world's second-largest economy, highlighted China's vulnerability to global demand.

"The global economy is at a precarious stage and downside risks have risen sharply," the IMF said, citing the possible deep crunch in the financial sector in Europe that would be felt around the globe.

"Should such a tail risk of financial volatility emanating from Europe be realized, it would drag China's growth lower."

The IMF outlined the negative impact if the eurozone crisis tipped Europe into a deep recession, dragging China's growth lower mainly due to shocks through trade.

In that "downside scenario" China's growth would fall by around 4.0 percentage points this year from the 8.2 percent rate the IMF projected in January.

"The risks to China from Europe are, therefore, both large and tangible."

In that case, "China should respond with a significant fiscal package."

China's exposure to financial spillovers is limited, it said, noting foreign assets, including sovereign debt, represent only 2.0 percent of Chinese bank assets.

However, the export-dependent economy is highly exposed through trade linkages. Nearly half of China's exports go to Europe and the United States.

Lower global demand would further reduce investment and employment and may trigger a decline in China's property market.

The IMF recalled that China's vulnerability was revealed in the 2008-2009 global financial crisis, when global growth plunged.

China launched a huge credit and fiscal stimulus in response, limiting the sharp impact on the domestic economy -- and yet growth still sank by five percentage points.

"However, a track record of fiscal discipline has given China ample room to respond to such an external shock," the IMF said.

If the euro area falters, the IMF recommended Beijing launch a substantial stimulus program, equivalent to roughly 3.0 percent of gross domestic product spread out over 2012-2013.

That would limit the decline in growth to around 1.0 percent, cushioning the negative fallout on employment and people's livelihoods, the IMF said.

The stimulus measures could include reductions in consumption taxes, advancing plans for social housing and scaling up investments in the social safety net, among others.

"Unlike in 2008, the stimulus package... should pass through the budget and not be reliant upon a public infrastructure," the IMF said, referring to the way the spending boost was previously dealt through the banking system, state enterprises and local government financing vehicles.

"The weak external outlook underscores the importance of accelerating the transformation of China's economy to reduce its vulnerability to the vagaries of global demand," it added.