Babies affected developed urinary problems, including kidney stones
China says it will launch nationwide testing of all dairy products following the deaths of three babies from contaminated milk formula.
More than 6,200 babies have fallen ill after drinking milk tainted with the toxic chemical melamine, officials say.
Tests have shown that 69 batches of formula from 22 companies contained the banned substance.
The Chinese government has described the dairy market as "chaotic" and said its supervision is flawed.
Two of the companies involved have exported their products to Bangladesh, Yemen, Gabon, Burundi, and Burma, although it is not clear if contaminated batches are involved.
The third fatality occurred in the eastern province of Zhejiang, Health Minister Chen Zhu said. The two earlier deaths had been reported in Gansu province.
More than 1,000 children were still in hospital, Mr Chen said, of whom more than 150 were suffering acute kidney failure.
He said all affected infants would receive free medical care.
In response, Li Changjiang, head of China's quality control watchdog, said 5,000 inspectors would be dispatched nationwide to monitor companies and begin testing for melamine in all dairy products, he said.
It is believed that the melamine, which is used in the production of plastics, was added to the fresh milk to make it appear to have a higher protein content.
People queue to return milk powder as infants are treated in hospital
In a statement, the Chinese cabinet said the incident reflected "chaotic industry conditions and loopholes in the supervision and management of the industry", state-run Xinhua news agency reported.
"It is necessary to learn lessons, properly deal with the incident, improve the inspection and supervision system and strengthen the management of the dairy industry," it said.
Companies caught up in the scandal include the giant milk company Mengniu Dairy.
It says it is recalling three batches of formula made in January, after government tests found melamine in its product.
The dairy has also suspended trading of its shares on the Hong Kong stock exchange.
The company at the heart of the scandal, the Sanlu Group, has fired its chairwoman and its general manager, the Xinhua agency said.
Chinese Health Minister Chen Zhu said all the seriously ill children had become ill after drinking Sanlu powered milk.
Correspondents say that melamine appears to have been added at milk collection stations, before being passed on to Sanlu.
Four officials linked to agriculture and quality control in Hebei province, where the Sanlu group is based, have been sacked, Xinhua reported.
The agency also said six people had been arrested in connection with the scandal and 22 were still being questioned.
Those arrested include two villagers charged with selling melamine and adding it to milk sold to the Sanlu Group.
An owner of a private food additive shop who allegedly sold the chemical to milk dealers was also arrested, as well as two milk sellers who admitted selling the tainted product, Xinhua said. Details of the sixth arrest were not given.
Sanlu made the information about the contamination of its products public last week after its New Zealand stakeholder, Fonterra - a global supplier of dairy ingredients - informed the New Zealand government, which then told the Chinese government.
Mr Li, head of the quality control watchdog, said two companies - Yashili and Suncare - exported milk powder and they were recalling their products.
On Wednesday, Bangladesh said food and commerce officials would meet this weekend to determine whether tainted products had entered the country.
Mr Li also said that melamine had also been found in a yogurt ice bar made by Yili, one of China's biggest dairy producers, and sold in Hong Kong.
The brand has now been recalled by the Hong Kong supermarket chain Wellcome.
Mr Li said tests for melamine had not been made before, because it was banned from food products.
The BBC's James Reynolds in Beijing says China is keen to try to reassure parents that it is in control of what is happening.
This scandal has undermined confidence in food safety in China and many parents are worried about what they will feed their babies, he adds.
Analysts say the incident is an embarrassing failure for China's product safety system, which was revamped after a spate of international recalls and warnings last year over a range of goods.