The International Monetary Fund (IMF) on Wednesday called on China to urgently upgrade its policy to move toward a more market-driven economic structure so as to avoid impacts on the whole international economy.

Jose Vinals, IMF’s financial counselor, warned that the cost for China’s failure to properly handle its policy to implement a more market- and consumption-based economic model could be a huge three percent of global output.

"The recommendation is for an urgent upgrade in policies, so as to avoid downside risks," Vinals said.

This followed an earlier warning by the IMF that the Chinese authorities face an unprecedented policy challenge in carrying out their objectives to make the transition to a new growth model and a more market-based financial system.

In the worst scenario, corporate default rates could rise, particularly in China, "raising financial system strains, with implications for growth," the report said.

A particular risk is that emerging markets' state-owned enterprises like those in the energy sector, which have raised huge amounts of funding by issuing bonds, could find themselves falling back on governments to service their debt.

That could raise the risk of governments seeing their credit grades lowered to non-investment grade or junk status, as happened to Brazil one month ago, the IMF warned in its report.