Cyprus's parliament overwhelmingly rejected a proposed levy on bank deposits as a condition for a European bailout this evening.
The vote by the small state's legislature was a stunning setback for the 17-nation eurozone.
It came after politicians in Greece, Portugal, Ireland, Spain and Italy had repeatedly accepted unpopular austerity measures over the past three years to secure European aid.
The rejection, with 36 votes against, 19 abstentions and one absence, brought the east Mediterranean island, one of the smallest European states, to the brink of financial meltdown.
EU countries said before the vote that they would withhold €10bn in bailout loans unless depositors in Cyprus shared the cost of the rescue.
The European Central Bank has threatened to end emergency lending assistance for Cypriot banks.
But jubilant crowds outside parliament broke into applause, chanting: "Cyprus belongs to its people."
Newly-elected President Nicos Anastasiades earlier told reporters he expected parliament to reject the tax on bank deposits "Because they feel and they think that it is unjust and it's against the interests of Cyprus at large."
Europe's demand at the weekend that Cyprus break with previous EU practice and impose a levy on bank accounts sparked outrage among Cypriots and unsettled financial markets.
Mr Anastasiades refused to accept a levy of more than 10% on deposits above €100,000, which meant taxing smaller accounts too.
That would have hurt ordinary savers with deposits that they thought came with a state guarantee.
Cypriot Finance Minister Michael Sarris flew to Moscow this afternoon to seek Russian financial assistance.
He denied by text message reports that he had resigned, which rattled nerves as lawmakers were poised to vote.
Stunned by the backlash, eurozone finance ministers urged Nicosia yesterday to avoid hitting accounts below €100,000, and instead increase the levy on big accounts, which are unprotected by the state deposit guarantee.
The European Union and International Monetary Fund are demanding Cyprus raise €5.8bn from depositors to secure its bailout, needed to rescue its financial sector.
A revised draft bill would have exempted savings under €20,000 from the planned 6.75% levy on deposits of less than €100,000, leaving a shortfall, but that was not enough to sway lawmakers, even in the ruling party, to accept the tax.
French Finance Minister Pierre Moscovici said the eurozone could not lend Cyprus any more, since the country's debt would become unmanageable.
"Above €10bn we are entering into a size of debt that is not sustainable," Mr Moscovici told reporters in Paris.
While Brussels has emphasised that the measure was a one-off for a country that accounts for just 0.2% of European output, fears have grown that savers in other, larger European countries might be spurred to withdraw funds.
Dutch Finance Minister Jeroen Dijsselbloem, who chairs the group of eurozone finance ministers, said there would be no need to impose a levy in other euro countries.
Deutsche Bank Chief Executive Anshu Jain told a Bundesbank conference in Frankfurt. "We see near term contagion risk as limited. This is unlikely to be a model for other European Union states."
Mr Anastasiades has continued to resist raising the levy on big deposits - many held by foreigners including rich Russians - fearing for the island's banking business model and reputation as a safe offshore financial haven.
He asked the EU for more aid during a telephone conversation with German Chancellor Angela Merkel yesterday.
Some Cypriots hope they could instead get aid from Russia, which has bailed out Cyprus in the past.
Many Russians keep their money in Cyprus and operate businesses from there.
Government spokesman Christos Stylianides said Mr Anastasiades might also speak to President Vladimir Putin, who had described the deposit levy as "unfair, unprofessional and dangerous".
Russian authorities have denied rumours that the Kremlin might offer more money, possibly in return for a future stake in Cyprus's large but as yet undeveloped offshore gas reserves, which have raised the island's strategic importance.
An influx of Russian money and influence since the collapse of the Soviet Union has led some Brussels officials to complain privately that Cyprus acts at times as a "Trojan donkey" for Moscow inside the European Union since it joined in 2004.
Stunned Cypriots emptied cash machines over the weekend and banks are to remain shut on today and tomorrow to avoid a bank run.
The island's stock exchange also suspended trading for another two days.