Joyce Banda, Malawi's foreign affairs minister, said on Monday: "We have decided to switch from Taiwan to mainland China after careful consideration on the benefits that we will be getting from mainland China."
The switch prompted an angry response from Taipei, with Taiwan's foreign ministry saying the island would break off ties with Malawi immediately.
In a statement, Taiwan also expressed regret that China had lured away another of its allies with financial incentives.
'Evil forces'
"It is with regret that the government and leaders of Malawi are unwilling to honour their promises to our government and have succumbed to China's evil forces," Taiwan's foreign ministry said in a statement.
China's foreign ministry confirmed on its website that they have established ties with Malawi.
The statement was accompanied by a large picture of a beaming Yang Jiechi, the Chinese foreign minister, shaking hands with a Malawian official.
Beijing and China's state-controlled companies have invested billions of dollars in Africa as China seeks to fuel its growing economy and increase its influence in the developing world.
Earlier this month, Malawian and Taiwanese media said Malawi cancelled a meeting with Taiwanese officials, raising speculation Lilongwe might end diplomatic relations with the island nation in favour of China.
Malawi's decision comes at a particularly bad time for Chen Shui-bian, the Taiwanese president, who has emphasised Taiwan's status as separate from China.
On Saturday, Chen's Democratic Progressive Party was devastated by the opposition Kuomintang in legislative elections.
Analysts said a major reason for the defeat was Chen's preoccupation with Taiwan's identity, and his failure to boost the island's sagging economy.