The Sanlu Group, a milk powder producer 43 per cent owned by Fonterra, was ordered to halt production last week.
An investigation found that the chemical compound melamine was present in its powder and leading to the creation of kidney stones in babies.
The chemical is used to make plastics, glues, fertilisers and cleaning products but can also be used to make milk's protein level appear higher than it actually is.
There is speculation that farmers or dealers supplying milk to Sanlu may have diluted it with water and then added melamine.
Normally inert, melamine can trigger the formation of kidney stones when it comes into contact with cyanuric acid.
Sanlu had first begun receiving customer complaints in March that babies' urine was discoloured and that some had been admitted to hospital, officials said.
The company said it had investigated the problem and recalled some products and sealed other contaminated powder.
"Those responsible for the contaminated milk will face severe punishment"
Chinese health ministy warning
But Gao Qiang, China's vice minister of health, said the company did not report to the government "for a considerable time" .
Fonterra said it was seeking a meeting with the Chinese government to discuss the issue.
China's investigation of the incident has widened to its dairy-producing regions, as officials attempt to track down the source of the melamine in the milk.
Nearly 80 people, including dairy farmers and milk dealers, have been summoned for questioning by police in Shijiazhuang, a city near Beijing where Sanlu is based, the state-run Xinhua news agency has reported.
Chinese state media has condemned Sanlu, with the China Daily newspaper on Saturday, calling the behaviour of the company "appalling".
Investigators said Sanlu knew the milk powder was contaminated in August [AFP]
The newspaper also sharply criticised government inspectors who it said had become aware of a possible problem as early as June.
The state-run Xinhua news agency said more sick babies may still be reported in at least five other provinces and regions.
Shops across China, including global spermarkets Wal-Mart and Carrefour, pulled the milk powder from shelves two days ago after a recall was issued.
The affair has had repercussions overseas, with the US Food and Drug Administration reportedly alerting US markets to beware of Chinese-made baby formula.
The World Health Organisation said it was monitoring the situation and providing "technical assistance" to the Chinese authorities in their probe.
It was not clear if any of the contaminated powder has been exported.
Taiwanese authorities on Saturday seized nearly 10 tonnes of milk powder imported from China, mainly of the Sanlu brand.
China has in recent years endured a series of high-profile safety scandals over its food and other products sold overseas, as well as domestically.
Melamine was at the centre of a US recall of pet foods containing Chinese-made additives last year.
In 2004, 13 infants in eastern China's Anhui province died of nutritional deficiencies after being fed sub-standard milk powder and over 170 infants fell sick in what the Chinese press said involved pirated Sanlu products.