Cao said China was "making effort to increase transparency", adding that the recent growth in spending had largely gone to salaries, uniforms and modernisation in line with China's drive to create a more professional military.
He also pointed to ongoing tensions with Taiwan which China has threatened with military force if it makes moves toward declaring formal independence from the mainland.
"I strongly hope Japan-China relations would improve even further with the visit of the Chinese defence minister here"Masahiko Komura, Japan defence minister
"China needs military spending because of the Taiwan situation," Cao was quoted as saying.
The meeting was aimed at bolstering defence co-operation between the two countries and improving overall ties.
Sino-Japanese relations have been strained in recent years over issues such as disputed territory and Japan's war time past.
In a bid to avoid friction with Beijing ahead of the talks, Japan did not extend its usual invitation to army officials from Taiwan to attend an annual military drill held near Mount Fuji last week.
Despite warming ties, concerns are still high in Tokyo about China's military build-up and marked rise in defence spending.
Japan's defence ministry lists Chinese military expansion as a top security concern in the region, and Japanese officials have labelled China a "threat", drawing rebukes from Beijing.
Tokyo also expressed alarm earlier this year when China successfully tested an anti-satellite missile, becoming only the third country to destroy an object in space.
Komura and Cao were expected to discuss the possibility of setting up a telephone hotline between their armies, and reciprocal port calls by navy ships.
Cao, who arrived on Wednesday for a five-day visit, addressed Japanese troops before Thursday's talks.