World number 24 Sindhu, who is the lone Indian woman in the fray in the absence of star compatriot Saina Nehwal, won 21-19, 9-21, 21-16 in a tense 45-minute contest against the second seeded and world number three Chinese.
Sindhu turned out to be more aggressive than her fancied opponent as she went on to hit as many as 26 smash winners as opposed to 20 by the Chinese. The net game was a close affair as the Indian had nine points to the Chinese's eight.
This was Sindhu's biggest win in her career. Sindhu came into the match high on confidence, having got the better of world number 14 and eighth seed Porntip Buranaprasertsuk of Thailand in the pre-quarterfinals of the tournament.
The 17-year-old Indian will now take on the winner of the match between Busanan Ongbumrungpan of Thailand and fourth seeded Yanjiao Jiang of China in the last four stage.
The young Indian straightaway opened a 3-0 lead and then made it 6-1 in the opening game before the Chinese reduced the gap to 6-7. Sidhu continued to maintain the lead but Xuerui used all her experience to make it 18-19.
It looked like Sindhu would wither under intense pressure from the vastly experience opponent but the Indian admirably held on to her nerves to take the first game 21-19.
Xuerui, however, came back strongly and it was the London Games gold winner Chinese who dictated terms on the Indian in the second game.
The Chinese was 8-0 up in no time and then extended the lead to 14-1 before making it 20-5. Sindhu made a bit of lost ground by winning four straight points but it was too little and too late as Xuerui took the second game 21-9.
Despite being outplayed in the second game, Sindhu showed that she can compete at the highest level by winning the decider and wrapping up the match. She led the Chinese opponent all through the decider.
It was a neck-and-neck affair for a while in the opening exchanges but Sindhu was up 14-7 and then 19-13 as she closed in for victory.
Xuerui made a last-ditch effort and reduced the gap to 16-19 but the Indian was too determined as she took two more points to script a famous victory.
Badminton Association of India (BAI) president Akhilesh Das Gupta congratulated Sindhu on her achievement.
"This is a big thing for Indian badminton. This will definitely inspire a lot of youngsters to take up the sport in the country," said Das Gupta.
Meanwhile, Ajay Jayaram came from a game behind to beat compatriot Sourabh Varma 12-21, 21-14, 21-16 in a quarterfinal battle that lasted 49 minutes.
In the semifinal, Ajay will take on the winner of the match between Bin Qiao of China and Hong Kong's Yun Hu.
RMV Gurusaidutt, however, crashed out of the tournament after going down to the top seed Long Chen of China 8-21, 12-21 in another quarterfinals clash of the men's singles event.