Japan's Foreign Minister Taro Aso has said China's military build-up is starting to be "a considerable threat".
Mr Aso is a well-known hawk on foreign policy
Mr Aso said Chinese military spending had seen double-digit growth every year for the past 17 and that it was unclear what this money was being spent on.
A Chinese government spokesman said the comments were irresponsible "rhetoric".
The exchange is likely to further strain relations between the two countries, ties which have seriously deteriorated over recent months.
Mr Aso, an outspoken hawk who was appointed foreign minister in October, was responding to a question in a news conference about a recent comment by the head of Japan's main opposition party, who had said he felt China was a threat.
Mr Aso said he agreed with Democratic Party of Japan leader Seiji Maehara.
Mr Aso said China was "a neighbour with one billion people equipped with nuclear bombs and has expanded its military outlays by double digits for 17 years in a row, and it is unclear as to what this is being used for," he said. "It is beginning to be a considerable threat."
He went on: "We would not be saying that [China] is a threat if the content of its military expenses are clearly known... the lack of transparency fans distrust."
Chinese foreign ministry spokesman Qin Gang dismissed Japan's concerns.
"As a foreign minister, to so irresponsibly incite such groundless rhetoric about a China threat, what is the purpose?" he said.
"China insists on a path of peaceful development. China's development has made commonly acknowledged contributions towards the world's peace and stability, bringing East Asian countries, including Japan, great development opportunities," he added.
The spat came as China's authorities issued a policy paper on the country's development strategy.
Called "China's Peaceful Development Road", the paper describes how soaring economic development in China would not pose a threat to other nations.
The 32-page document said China's development was instead creating opportunities and bigger markets for the rest of the world.
Correspondents say the policy paper echoes themes in recent speeches abroad by China's leaders in which they have been seeking to quash concern, particularly in the US and Japan, about Chinese nationalism and increased global competition for resources.
China and Japan have been engaged in a number of disputes this year, over oil resources and Japan's attitude to its colonial and wartime history.
China cancelled a regional summit with Japan earlier this month in protest at continuing visits by the Japanese prime minister, Junichiro Koizumi, to a controversial war shrine.
There were a number of attacks against Japanese diplomatic and commercial buildings earlier this year as Chinese crowds staged angry protests over Japanese school textbooks which they said misrepresented history.