As part of the 10 billion-euro ($13.7 billion) deal with the EU and International Monetary Fund (IMF), lawmakers have until March 5 to pass a bill allowing state firms to be privatized.
On Thursday, the lawmakers threw it out, jeopardizing the next tranche of cash.
The government says it will re-submit the bill with some amendments.
The deal was agreed in March last year in an attempt to stave off the collapse of Cyprus’s banking sector and the wider economy.
It included moves to restructure the banks, along with other measures such as tax rises and privatizations.
Late on Thursday, the privatization bill was narrowly defeated after parliament split 25-25 on the vote, with five abstentions. This meant the legislation failed to pass.
The vote took place as hundreds of people opposed to privatization staged a protest outside the parliament building.
A government spokesman, Christos Stylanides, said the bill would be amended to reflect concerns over workers’ rights after privatization.
The new version of the bill would be submitted to the House of Representatives on Friday.
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