Cheap woollen and cotton clothes made in China and exported abroad have been found to contain 500 times the amount of the chemical considered safe.
Formaldehyde, used on fabrics for decades to keep them wrinkle-free and stain-resistant, also serves as protection against mildew for consignments that have to travel long distances.
This week, New Zealand's media reported that tests on children's and adults' woollen and cotton clothes from China had found formaldehyde concentrations up to 900 times above the safety limit.
New Zealand's ministry of consumer affairs said it was investigating the "nature and size of the problem".
A British website subsequently said that the alert has been passed on to trading standards officials in Britain.
Britain's trading standards departments were expected to carry out tests to establish formaldehyde levels, Thisislondon.co.uk quoted Bryan Lewin, chairman of the Trading Standards Institute, as saying.
"The details will re-ignite concerns over the safety of cheap merchandise imported into Britain from China," the website said. If China's imports to the West are found to be violating the safety standards, its merchandise to Nepal would prove immensely more harmful.
Nepal's markets are flooded with cheap Chinese goods that are smuggled in, causing a loss to both the Nepal government and consumers. Nepal, one of the poorest countries in the world with the weakest law enforcement, is used as a dumping ground for inferior Chinese goods that meet no standard requirements, have no warranty and pay no taxes.
Nepal's Chinese goods are a byword for inferior quality and known to go out of order in record time. Yet they continue to dominate the market as they are fiercely competitive, which they can afford to since they do not pay any taxes either in China or Nepal.
Nepali manufacturers complain that the flood of cheap Chinese goods is pushing them out of business. Though the Nepal government this month directed that all foreign goods being sold in Nepal must bear labels clearly indicating the expiry date and other details in the local languages, Chinese goods continue to circulate in the market with labels incomprehensible to the average buyer.
Last week, toy giant Mattel had to recall millions of Chinese-made toys after safety fears over small magnets used in some and about paint containing high levels of toxic lead in others.