The chief prosecutor said the National Prosecution Authority (NPA) had obtained recordings of phone conversations which suggested the timing of the decision to charge Mr Zuma in 2007 had been manipulated.
"I have come to the difficult conclusion that it is neither possible nor desirable for the NPA to continue with the prosecution of Mr Zuma," Mr Mphse said.
The chief prosecutor read out transcripts of recorded conversations between former NPA head Bulelani Ngcuka and Leonard McCarthy, the man who led the now disbanded anti-corruption unit known as the Scorpions.
Mr Mpshe said the pair had discussed timing charges against Mr Zuma to cause political damage.
"Mr McCarthy used the legal process for a purpose outside and extraneous to the prosecution itself," he said. "It was pure abuse of process," Mr Mpshe added.
The main opposition Democratic Alliance said it would apply for a judicial review of the decision.
What we have seen here today is a show trial two weeks before an election
Party leader Hellen Zille said: "What we've seen here today is an abuse of the NPA's role.
"What we have seen here today is a show trial two weeks before an election by the National Prosecuting Authority using a press conference as if it's a court of law."
The Congress of the People (Cope), a recently formed political party that broke away from the ANC, said in a statement: "South Africa deserves better.
"The dream of 1994 is dying, killed by the ANC and its alliance partners - South Africa is in great peril," it added, referring to the nation's first democratic vote at the end of white minority rule 15 years ago.
Sacked as deputy president
Charged with corruption
Charged with rape
Acquitted of rape charges
Corruption case collapses
Elected ANC president; re-charged with corruption shortly afterwards
Judge rules corruption case cannot proceed
Prosecutors win appeal, opening the way for Zuma to be recharged
6 April 2009:
Prosecutors drop charges after receiving new phone-tap evidence
Earlier, opposition Inkatha Freedom Party leader Mangosuthu Buthelezi told the BBC: "If the charges are just dropped when there is no trial it seems to me the stink of what they accused him of will not go away."
Mr Zuma was first charged with graft, racketeering and money-laundering in 2005, but never faced trial.
The case was dropped the following year, but he was recharged 10 days after he defeated former South African President Thabo Mbeki in elections to be the ANC's leader in December 2007.
Last year a judge ruled that there had been political meddling in the case, but the NPA successfully appealed.
The BBC's Africa analyst Martin Plaut says despite mountains of evidence, South African justice has proved incapable of dealing with a case that has been wrapped up in the internal workings of the governing party - the ANC.
The prosecutor provided evidence that his predecessor had manipulated the case to suit the ANC, yet said plainly that he had no evidence that this had been done at the behest of Mr Mbeki.
Despite the outcome of the affair it is likely to taint Mr Zuma's presidency and the governance of the country as the ANC leader has not had a chance to clear his name in court and the country will not forget the serious allegations, he says.
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