Fabric to be used for cheesecloth

The problem with buying tailoring fabric for food use is that sometimes such fabric is treated. Many treatments are not especially problematic (for example starch), but there are others - there is a method for making shirt fabric wrinkle-free which uses formaldehyde.

It is the best to buy real cheesecloth, created for this purpose. The second best option is to buy uncolored organic fabric, it's seldom treated. If you can get neither, a tea towel is also a good option. It's supposed to be used in food settings, cheap, and does not have to have any special features as cloth, so it's unlikely that it's treated. Its dye is probably also quite leak-prone, as tea towels should be able to be washed at very high temperature. But still, if you can find white (or even better, unbleached) towels, they'll be best, because textile dyes can be toxic themselves.

If you really have to get it in a fabric store, go for pure cotton. (Flax should work, but it's unnecessarily expensive). You need it in plain weave, no twill, satin or anything else. And somewhat loose weave is indeed best, as Joe already mentioned. It should be fairly thin, too. "Standard" muslin will probably work more or less, but not as good as regular cheesecloth, as it's a bit too tightly woven.

Another option is to find out if somebody can sell you gauze meant for dressing wounds. It is loose enough, and untreated. It will allow you to make somewhat soft paneer. If you want to press yours very firm, gauze will probably tear. It is also probably not so easy to find, as nowadays there are other products used for wound dressing.

I use cloth diapers.
The old-fasioned kind, without print (and never used for the original purpose, of course). They are pure cotton, can be boiled and are just the right balance between density and looseness. Pretty cheap, too.
I prefer their square shape over rectangular tea towels when it comes to tying the corners to filter/press something.

Basically cheesecloth by another name.

Edit: Here is a link where these cloth diapers are used for paneer (recipe in german).

Use a handkerchief! :) This works well!

Re-inventing the wheel is not always wise. Unless you place no value whatsoever on your time, you can't beat the cost of cheesecloth. You can get it at Walmart for less than a dollar a yard.

If you're hellbent on making your own, you will need to craft a loom. Use firring strips to make a frame in the desired size. Place headless nails at evenly spaced intervals. Craft a fine toothed comb from wood. Get 100% cotton thread and get weaving (you'll be able to find all the info you need on warping your loom by googling). Off the top of my head, I think you'll pay more for the thread than you would for already woven cheesecloth but, if this is what you want to do, go for it!