The international community is watching to see whether the Taiwanese people possess the resolve to defend themselves, Lai said in a New Year's speech broadcast live from the presidential office in Taipei.
The US State Department said China's military activities near Taiwan and others in the region "increase tensions unnecessarily" and urged Beijing to halt military pressure against the democratically governed island.
"As president, my stance has always been clear: to resolutely defend national sovereignty and strengthen national defence," Lai said, noting China had targeted Taiwan's newly added combat capabilities as a "hypothetical adversary" in their drills this week.
He said that demonstrated the need for increasing defence procurement, urging opposition parties to support his plan to boost Taiwan's defence spending by $US40 billion, a proposal currently stuck alongside other issues in a political deadlock in the opposition-controlled parliament.
"Whether China can achieve its goals on schedule is one thing," Lai said when asked about a US report saying China was preparing to have the capability to win a fight for Taiwan by 2027.
"The coming year, 2026, will be a crucial one for Taiwan," he said, adding Taiwan must "make plans for the worst, but hope for the best."
"We are willing to engage in exchanges and cooperation with China on an equal and dignified basis, promoting a peaceful and shared environment across the strait," Lai said.
"As long as China acknowledges the existence of the Republic of China, respects the Taiwanese people's desire for a democratic and free way of life."
China claims Taiwan as its own territory, and it has not ruled out using force to take it under Chinese control. Taiwan rejects China's claims.
After Lai's address, China said he was trying to deceive Taiwanese and mislead international public opinion.
"Lai-Ching-te's address is riddled with lies and reckless assertions, hostility and malice," a spokesperson for China's Taiwan Affairs Office said in comments reported by state broadcaster CCTV.
China fired dozens of rockets towards Taiwan and deploy a large number of warships and aircraft near island in a show of force that drew concern from Western allies including the European Commission and Britain.
Taipei condemned the drills as a threat to regional security and a blatant provocation. Beijing announced late on Wednesday that it had completed the drills, saying its military would continue to strengthen their combat-readiness.
China's President Xi Jinping struck a familiar tone on Taiwan in his New Year's address, repeating last year's warning to what Beijing considers as separatist forces that China's "reunification" with Taiwan can not be stopped.
"We urge Beijing to exercise restraint, cease its military pressure against Taiwan, and instead engage in meaningful dialogue," US State Department spokesperson Tommy Pigott said in a statement.
The drills, China's largest by area and the closest yet to Taiwan, forced the island to cancel dozens of domestic commercial flights and dispatch military jets and warships to monitor the exercises.
The Chinese manoeuvres began 11 days after the United States had announced a record $US11.1 billion arms package for Taiwan. China's military said for the first time that the drills were aimed at deterring outside intervention.
