Annan, in a speech presented by his special representative Lakhdar Brahimi, insisted war was "not inevitable" and warned any action not sanctioned by the United Nations would lack legitimacy.
However, he urged Iraq to disarm for the sake of world order.
"For the sake of its own people, and for the sake of world security and world order, I urge the Iraqi leadership to choose full transparency and cooperation with the inspectors to help avoid conflict," Annan told leaders of the 116-nation body, including Iraqi Vice President Taha Yassin Ramadan.
"Iraq must disarm. It must cooperate fully and proactively with the inspectors," he added.
Annan's speech was presented as the United States continued a diplomatic push for support for a second UN Security Council resolution on Iraq.
As Secretary of State Colin Powell arrived in China, also a UN Security Council permanent member, military preparations continued with US strategic bombers beginning practice runs over the Gulf region.
President George W. Bush has warned the United States will go it alone if the UN does not pass a resolution authorising the use of force against Iraq within two months.
Annan drew attention to the humanitarian situation in Iraq, where he said five million people lacked access to clean water and sanitation.
He also highlighted the plight of ordinary Palestinians living in Israeli-occupied territories and said they would continue to suffer until a political solution was found to the conflict.
"The human and material losses sustained by the Palestinian people in the last two years have been nothing short of catastrophic," Brahimi said.
NAM, which consists mainly of developing countries and has been meeting since 1961, was conceived as an alternative to the Eastern and Western blocs during the Cold War.
East Timor and St. Vincent and the Grenadines joined the forum at the Kuala Lumpur summit, bringing its total membership to 116 - Sapa-AFP.