Beijing was also forced to defend its rare earths exports policy on the second and final day of Merkel's China trip on Friday (31 August), with Premier Wen Jiabao saying China was not intentionally holding back exports amid a supply squeeze that has driven up prices.
China accounts for more than 90% of the global supply of rare earths - essential for the defense, electronics and renewable-energy industries.
During a visit to Wen's home city of Tianjin, just outside of Beijing, Merkel made clear that China needed to make concessions if it wanted to prevent EU action over the solar spat.
The European Commission has until Friday (7 September) to decide whether to launch an investigation into a complaint brought by European solar firms and people familiar with the case believe it may well go ahead and do so.
Merkel earlier told reporters after talks with Wen that she favored negotiations over confrontation in the matter, comments that were welcomed by the Chinese premier but stoked concern in the European industry.
But on Friday she appeared to row back on her conciliatory tone, saying Chinese solar firms needed to recognize that subsidies, such as bottom-rate bank loans, distorted competition and violated European law.
"We are not out of the woods yet," she said. "My plea is that everyone be transparent, that they lay their cards on the table about how they produce."
Last month a group of European solar companies, led by Germany's SolarWorld, filed an anti-dumping complaint against Chinese rivals with the European Commission.
Chinese solar firms have called on the Chinese government to retaliate if Brussels decides to act on the complaint. The United States imposed duties on solar panel imports from China in May after a similar initiative led by SolarWorld there.
"Chancellor Merkel's comments may not be all that it takes to prevent [trade] Commissioner Karel De Gucht from opening the investigation," Vasiliki Avgoustidi, associate director at Berwin Leighton Paisner LLP in Brussels, said.
In the last few years, Western solar firms have accused Chinese peers of receiving lavish credit lines to offer modules cheaply in Europe while protecting their own market.
Almost 60% of China's solar exports, worth €28.5 billion, were shipped to the EU last year.
China defends rare earth policy
In another contentious trade matter concerning China's rare earths, Wen said Beijing did not intend to curb its exports and wants the issue resolved via cooperation rather than by filing complaints.
The World Trade Organization has said it will look into complaints made by Europe, Japan and the United States over China's limits on exports of rare earths.
China has been reining in its exports in recent years, drawing the ire of trade partners who say the curbs are unfair.
China says the export restrictions are needed to help protect the environment. It released a new round of rare earths export quotas this month, raising its 2012 export quota to 30,996 tonnes, despite a crackdown on small producers.