In what is being regarded as a diplomatic coup for Beijing, the Panamanian government said it recognised only one China and considered Taiwan part of it.
But Taiwan has expressed anger and regret over the action, and accused Panama of bullying.
China has been waging a global campaign seeking to isolate Taiwan, which it regards as a breakaway province.
Taiwan now has diplomatic relations with only twenty countries, which are mainly small island states or in Central and South America with limited economic ties with China.
