The vote leaves the tiny Mediterranean economy in financial limbo, but hundreds of protesters outside Parliament cheered and sang the national anthem when they heard the bill failed.
Cyprus needs 15.8 billion euros ($20.4 billion) to bail out its heavily indebted banks and shore up government finances. If it doesn't get the money, the banks could fail, Cyprus' government finances could be ruined for years and the country could face expulsion from the 17-country euro currency union. Eurozone countries and the International Monetary Fund have pledged to provide 10 billion euros ($12.9 billion) in rescue loans if Cyprus can come up with the remainder.
With the country's banks closed since Saturday to avoid a run, Cypriot leaders will now try to hatch a more politically palatable plan that might also satisfy officials in the eurozone and IMF.
The plan that was rejected Tuesday — with 36 votes against, 19 abstentions and one absence — had been amended to shield the smallest depositors, those with under 20,000 euros ($25,858) in the bank. But deposits up to 100,000 euros ($129,290) are supposed to be insured by all euro countries. There has been widespread condemnation of the plan throughout Europe since it was announced over the weekend.
Global financial markets were on edge Tuesday, but investors so far have taken the latest turmoil in Europe in stride. The Cypriot economy is tiny and there is hope that Europe's political leaders can find a way to bolster the country's finances and prevent it from leaving the euro. After the Cypriot vote came in, the Dow Jones industrial average ended the day 3 points higher at 14,455. Earlier in the day, European markets closed slightly lower while the euro edged down 0.4 per cent against the dollar.
"This is not the end of the process, but instead kicks off a further round of negotiation," said Alex White of JPMorgan. "The Cypriot authorities wanted to conduct the vote so that they could reaffirm the extent of their difficulties to the Europeans."
Part of the reason for the market calm is that the European Central Bank has promised to do whatever it takes to protect the euro. It has a plan in place to buy the government debt of any countries that fall into financial trouble, provided they ask for help. That has helped keep bond market borrowing rates manageable for Italy and Spain, for example.
The ECB said after the Cyprus vote that it would continue providing liquidity to Cypriot banks to prevent their immediate collapse. Some had feared that if Cyprus rejected the bailout, the ECB might stop providing support, letting the banks fail.
Of the 15.8 billion euros ($20.4 billion) that Cyprus needs, roughly 8.3 billion euros ($10.73 billion) is for its two top lenders — Bank of Cyprus and Laiki Bank, which is effectively controlled by the government already. About 7.5 billion euros ($9.7 billion) would be used to finance the country's deficits over the next 4 years and to cover a 1.5 billion euro ($1.94 billion) debt payment that comes due in June.
Cypriot political leaders will meet with President Nicos Anastasiades on Wednesday to discuss the next steps.
Nicholas Papadopoulos, the chairman of the parliamentary finance committee, said Cyprus wants a renegotiation of its bailout deal but was against the idea of seizing savings. "It has not been (implemented) in any other country in Europe and we don't wish to be the experiment of Europe."
He said a new agreement could be concluded "in the next few days." In the meantime, the banks will remain shut for as long as needed. ATMs have been dispensing cash and debit and credit cards were working normally. The amount of the proposed tax had been blocked in people's accounts, but with the bill rejected, it was unclear whether that would continue. Electronic transfers continued to be blocked.
Germany, one of the eurozone's heavyweights, made clear its frustration at the Cypriot vote. The finance minister, Wolfgang Schaeuble, noted that Cyprus' banks were surviving only because of ECB help and that if there is no bailout deal, the ECB will have to end that support.
"Someone needs to explain this to the Cypriots," Schaeuble told German public television ZDF.
Some help could come from Russia, a longtime ally of Cyprus. But those talks have been strained by the announcement of the deposit seizures, since Russians hold up to a third of the 68 billion euros ($87.92 billion) in deposits in Cyprus.
Cyprus could seek to extend repayment of a 2.5 billion euros ($3.23 billion) loan Russia granted Cyprus in late 2011, when the country could no longer borrow from international markets.
The Cypriot finance minister is in Moscow to discuss financial aid while Anastasiades, the president, spoke with President Vladimir Putin after the vote.
For Cypriots who risked losing a chunk of their life savings in the bailout deal, the parliamentary vote was a moment to rejoice — and think ahead.
"We shouldn't lose our cool," said Panayiotis Violettis, a 56-year-old retired government worker. "When banks open, if we pull all our money out, it would be like we would be punishing ourselves."
Insurance salesman Lambros Kannaouros, who has almost 50,000 euros ($64,645) in the bank, said his options were limited: "I'm not going to do anything. What I'm I going to do? Where will I take it? Where will I put it?"
Although Cyprus is the smallest eurozone country to be bailed out, its rescue plan had sent shockwaves through the single currency area as it was the first time savers' banks accounts have been directly targeted. Other bailed out countries such as Greece, Ireland and Portugal have raised funds by imposing new taxes.
Proponents of the deposit seizure argued it would have made foreigners who have taken advantage of Cyprus's low-tax regime share the cost of the bailout.
Andreas Charalambous, a senior official at the finance ministry, said Cypriot authorities believe depositors should be protected, but that a wholesale exemption for those below 100,000 euros ($129,290) would mean a "disproportionate" burden on large savers, and a "very detrimental" knock-on effect on economic growth.
Under the original bailout plan sketched out in Brussels early Saturday, Cyprus agreed to raise 5.8 billion euros ($7.5 billion) by taxing bank accounts. In exchange, it would receive the 10 billion euros ($12.9 billion) in rescue loans from other eurozone countries and the IMF. Depositors with less than 100,000 euros ($129,290) would pay 6.75 per cent; deposits above that threshold would be taxed 9.9 per cent.
But the change made Tuesday to protect small depositors was not enough for lawmakers.
"It was not possible for the Cypriot parliament and its people to accept such an unfair, disagreeable and one-sided proposal," Education Minister Kyriakos Kenevezos said on Greek state NET television. "Now we are faced with very difficult developments ... No one must panic because panic never helps solve any problem."
Steve Rothwell in New York, David McHugh in Frankfurt and Frank Jordans in Berlin contributed to this report.