The new entity, called Nutrition Science Partners (NSP), is to be owned equally by the two parties, the Swiss company said on Wednesday.
The company did not disclose the financial details behind the deal.
NSP will research, develop, make and sell nutritional and medicinal products derived from botanical plants, the Vevey-based company said in a statement.
The joint venture will also hand Nestle's Health Science division, which is handling the deal, access to Chi-Med's traditional Chinese medicine library.
With more than 50,000 extracts from more than 1,200 different herbal plants, the medicine library is one of the world's largest, the company said.
Initially, the product focus will be on gastro-intestinal health — a market worth up to $6 billion (4.6 billion euros) according to Chi-Med — but could in future expand into metabolic diseases and brain health, Nestlé said.
For Chi-Med, the deal, which is still subject to regulatory approvals, will bring "a stream of novel botanical medicines and nutritional products to market and in so doing build significant value for patients and for our shareholders," company chief executive Christian Hogg said on a conference call.
"Botanical are in the forefront in our view in the search for new medicines," the Chi-Med chief said.
Traditional Chinese plant-based medicines represented between 30 percent and 40 percent of all pharma sales in China, he added.
This joint venture provides Nestlé Health Science with an opportunity to develop and commercialize truly innovative and scientifically validated botanical-based nutrition for personalized healthcare in gastrointestinal health, Nestlé Health Science head Luis Cantarell said.