In an announcement on Monday, Panama's government said it recognized there was "only one China in the world" and that Taiwan was an inalienable part of Chinese territory.

"The Panamanian government is today breaking its 'diplomatic ties' with Taiwan, and pledges to end all relations or official contact with Taiwan," according to the statement. The decision reduces to 20 the number of countries that recognize Taiwan rather than Beijing as representing China.

Panamanian President Juan Carlos Varela said in a televised address that it was the "correct path for our country."

"We have taken a historic step," Varela remarked. "Both countries opt for the connection of a world that is more and more integrated, which creates a new era of opportunities for a relationship that we are starting today."

A joint statement released on Monday evening confirmed that Panama and China were recognizing each other and establishing ambassador-level relations as of the same day.

China links

As well as being the second-biggest client of the Panama Canal, China is also the main provider of merchandise to the free-commerce zone in the city of Colon, on the Caribbean side of the country. It also plays a key role in business sectors ranging from banking to telecommunications.

Panama's legal and financial sectors have been highlighted in an international tax-avoidance case after more than 11 million documents were leaked detailing financial and attorney-to-client information about more than 200,000 offshore entities. The so-called Panama Papers belonged to law firm and corporate service provider Mossack Fonseca.

Political and business leaders around the world were found to have been named in the Panama Papers.

av/jm (Reuters, AP)