And Tokyo's Jiji news agency said China had called on Japan to send its military to help with relief operations.
The Tangjiashan Lake was created when landslides caused by the May 12 earthquake blocked the Jianjiang river above the town and county of Beichuan in mountainous Sichuan province, near the epicentre of China's most destructive earthquake in decades.
The official death toll from the 7.9 magnitude quake is already more than 67,000 and is certain to rise further, with nearly 21,000 listed as missing. The quake injured nearly 362,000 people and new aftershocks toppled 420,000 houses, many already uninhabitable, on Tuesday.
Downstream from the lake, residents were evacuated overnight as engineers dug a diversion channel to prevent flooding.
Up to 1.3 million people could be relocated if the lake barrier collapses entirely, the China Daily said in its online edition.
Residents of Taihong looked on as the landslide demolished their village. Han Haiyun, 60, was lucky to be away from her house at the time.
"I would never have thought something like this could happen in my life," she said. "It's impossible to put into words."
The water level in the lake, one of 35 "quake lakes" formed by the tremor and holding the volume of about 50,000 Olympic-size swimming pools, has kept rising and the giant sluice would not be ready for another week, the China Daily quoted experts as saying.
Immediately below the lake, the river runs in a loop between flattened high- and low-rise buildings, but threatens communities downstream whose residents held evacuation drills on Tuesday.
Beijing on Wednesday allocated CNY200 million (Dh106 million) to Sichuan especially for defusing the threat of the quake lakes, 28 of which were still rated as dangerous, Xinhua news agency said.
It also urged Japan to send its military to help with rescue operations, Jiji said, in what would be the first time Japan's military has been deployed in China since the end of World War Two.
Jiji quoted an unnamed Foreign Ministry official as saying that Japan had started to consider the request, while Kyodo news agency said China had sounded out Tokyo about sending military planes to help transport relief materials.
Sino-Japanese ties, long troubled by Japan's brutal occupation of parts of China from 1931-45, have been on the mend in recent months.
In Tianlin village, among the first to be flooded if the lake bursts, gongs and loudspeakers directed 680 villagers to rush to surrounding hills within 20 minutes.
The lake water level was 727.09 metres on Tuesday, only 24.21 metres below the lowest part of the unstable landslip barrier.
Over the last century, about 5,500 people have been killed by flash floods when barrier lakes burst through dams made by landslides, according to a 2004 paper by geologists at the Chinese Academy of Sciences.
In 1786, the breach of a landslide dam 10 days after a major earthquake killed about 100,000 people in Sichuan.
The region along the faultline is densely packed with dams, raising concerns that if either the quake lakes or the weakened dams burst, the rush of water could cause other dams to fail.
The earthquake will make it difficult for China to meet its target of limiting inflation this year, a senior official said because of the damage to agricultural production and heavy investment in reconstruction work.
Asked how difficult the earthquake would make it for China to meet its 2008 inflation target of 4.8 per cent, Xu Xianchun, deputy head of the National Bureau of Statistics, said repeatedly: "Very hard."
Life for the millions of homeless is tough. Apart from the threat of flooding disasters, officials are trying to stave off epidemics as the temperature rises and the rainy season approaches.
Some 730 rural families in Jiangyou got 1 kg of pork each on Tuesday after rescuers slaughtered six pigs, the first time they had had meat since the disaster struck, Chinese media said.
A massive relief effort, which involves providing food, tents and clothing for millions and the reconstruction of housing and infrastructure, is expected to take up to three years.