* Panama breaks ties with Taiwan, recognises "one China"
* China is Panama Canal's second most important customer
* Recognition comes as a coup for China
* Rival waterway deal in Nicaragua now in doubt (Recasts throughout with severing of ties with Taiwan, adds Panama president's quotes, background)
PANAMA CITY, June 12 (Reuters) - Panama established formal diplomatic ties with China and broke with Taiwan on Monday in a major victory for Beijing that bolsters its claims of sovereignty over what it regards as a renegade island.
Panamanian President Juan Carlos Varela said in a televised address Panama was upgrading its commercial ties with China and establishing full diplomatic links with the second most important customer of its key shipping canal.
"I'm convinced that this is the correct path for our country," Varela said.
Panama's government said in a statement that it recognized there was only one China, with Taiwan belonging to the Asian giant, and that it was severing ties with Taipei.
"The Panamanian government is today breaking its 'diplomatic ties' with Taiwan, and pledges to end all relations or official contact with Taiwan," the statement said.
China has commended Panama for its decision, Chinese state television reported.
The establishment of links with Panama is a coup for China, which has been showering largesse on countries throughout Central America in recent years in an attempt to get them to break ties with Taiwan.
As recently as December, Panama's deputy foreign minister had said he did not expect any change in Panama's relations with Taiwan or China.
Panama is one of Taiwan's oldest friends, but some diplomats in Beijing had speculated that the Central American country could become the next nation to break ties.
Taiwanese President Tsai Ing-wen visited Central American allies earlier this year but did not stop in Panama.
Monday's diplomatic move could also raise questions about the future of a Chinese-backed project to build another Central American waterway to rival the Panama Canal in Nicaragua.
Earmarked at a cost of $50 billion, the Nicaraguan scheme was met with widespread incredulity when it was announced in 2013, and critics have raised questions about its feasibility. (Reporting by Elida Moreno; Writing by Gabriel Stargardter; Editing by Paul Tait)