Regarded as big blow for Taiwan, China and Panama signed a joint communique here formally establishing full-fledged diplomatic relations.
Chinese Foreign Minister Wang Yi met with Isabel Saint Malo de Alvarado, Panama's vice president and foreign minister, state-run Xinhua news agency reported.
They signed the joint communique in which Panama has recognised One China, meaning that Taiwan is part of the Chinese mainland.
"I'm convinced that this is the correct path for our country," Varela said.
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Taiwan expressed "anger and regret" over the "very unfriendly" diplomatic turn by Panama that "yielded to economic interests by the Beijing authorities".
It accused Panama of "bullying" Taiwan while "ignoring the many years of friendship" between the two countries, and added it would "not compete with the Beijing authorities for money diplomacy".
Last June Taiwan's leader Tsai Ing-wen, a strong advocate of Taiwan's independence from China visited Panama, on her first overseas trip as President.
The move by Panama comes as China began construction of a container port with natural gas facilities in northern province of Colon last week.
For long, Panama has maintained that it has commercial ties with China and diplomatic ties with Taiwan.
Taiwan, which broke away from China in 1949, is coming under immense pressure from China's push with huge funds of Belt and Road Initiative. Panama is the latest country to cut ties with Taiwan.
In December last year, the African island nation of Sao Tome and Principe made a similar move. Now only 20 countries have diplomatic relations with Taiwan.
Panama did not give any reason for changing its diplomatic allegiance but there has been growing economic co- operation with China in recent years.
China's foreign ministry also released a statement saying that "the Chinese government and its people highly appreciate and warmly welcome" the move by Panama.
Chinese companies are developing ports in Panama, and Chinese state firms are said to have expressed interest in developing the land around the Panama Canal once the country opens a tender for it later this year, media reports said.
The Panama Canal is a vital shipping route. As China expands its global trade ambitions with its One Belt One Road infrastructure-building initiative, access to the eastern coasts of both South America and the US is expected to be of growing importance for Beijing, the report said.
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