After 91 per cent of the votes were counted, Netanyahu's centre-right Likud party stood at 31 seats, while its main rival the centrist Blue and White party of Benny Gantz was at 32 seats, according to the Central Election Committee cited by Haaretz newspaper.
Both right-wing bloc and centrist and left-wing block were set to fall short of the 61 seats needed to form a governing coalition in the 120-seat Parliament, known as the Knesset.
The result can have huge implications for the Middle East at a time of renewed tensions between the US and Iran.
A close ally of US President Donald Trump, Netanyahu is likely to continue to pursue his hardline stance towards Palestin if he remains Prime Minister, putting a two-state solution further out of reach, media reports say.
Netanyahu Israel's longest-serving Prime Minister has been in office for 10 years.
On the other hand, Blue and White leader Benny Gantz, a former Army chief of staff, has campaigned on a promise of clean government and social harmony. He has called for pursuing peace with Palestin while maintaining Israeli security.
Another issue is that Netanyahu could potentially be indicted in three corruption cases. If he remains the Prime Minister, then he may be able to pass legislation that would grant him immunity, but if he loses he may have to appear in court and even face time in jail.
Early Wednesday morning, Netanyahu refused to concede defeat and vowed to form a new government that excludes Arab parties.
"In the coming days we will convene negotiations to assemble a strong Zionist government and to prevent a dangerous anti-Zionist government," he said.
He claimed that Arab parties "negate the existence of Israel as a Jewish and democratic state" and "glorify bloodthirsty murderers."
On Wednesday morning, Yisrael Beiteinu party's leader Avigdor Lieberman, reiterated that he would only support a government comprising both Likud and Blue and White.
However, Blue and White has ruled out sitting with Netanyahu in a coalition. Instead, Benny Gantz offered to form a national unity government and said he had already reached out to the heads of the two centre-left Zionist parties, the Labour Party and the Democratic Union.
The unprecedented do-over election followed an inconclusive vote in April.
Netanyahu was unable to form a government after his former ally Lieberman refused to join his coalition because he was opposed to the influence of ultra-Orthodox religious parties.
Instead of risking another leader being able to negotiate a coalition government, he dissolved Parliament, triggering a snap election.
In order to form the next government, one party will have to cobble together a coalition that commands 61 out of the 120 seats in the Israeli Parliament. It is usually the leader of the largest party that gets to attempt to form a government within the 42 days allocated.
No party has ever won a majority in Israeli politics.
( With inputs from IANS )