The assembly broke out into cheers and cries of "Allah is great!" as the number of votes rejecting Mr Habibie's defence of his rule passed the majority. The final vote was 355 against 322.

The 700-member People's Consultative Assembly (MPR) will decide on Wednesday who will lead the country for the next five years.

The legislators' rejection of Mr Habibie could prompt the ruling Golkar Party to replace him as its presidential nominee.

The BBC's Matt Frei: "The assembly has become a bazaar"

The vote on his 17 months in office came as thousands of people - some of them armed - rallied in the capital, Jakarta.

The demonstrations are taking place despite an official ban on any protests in the city centre. So far there have been no reports of any trouble.

Crucial vote

Mr Habibie has been strongly criticised both inside and outside the assembly for his failure to curb corruption and his handling of the crisis in East Timor.

Soon after the vote on his rule, the assembly endorsed East Timor's independence vote, paving the way for the half-island territory to become the world's newest nation.

Mr Habibie has also been tainted by his closeness to the discredited former President Suharto.

In the hot seat: Habibie listens to the day's debate

On Monday, in a further setback to Mr Habibie's election hopes, armed forces chief General Wiranto turned down an invitation to act as his running mate.

In an ambiguous speech televised on Monday night, he said he did not want to become involved in elite politics.

The BBC's Jonathan Head: "A serious blow to Habibie's hopes of retaining power"

He said he preferred to concentrate his energies on "safeguard[ing] the nation's security", but would be prepared to enter political office if the people wanted him to.

Later his spokesman, Brigadier-General Sudrajat, told the BBC that the general was "open to nomination if it comes from the majority of the people".

Megawati's troubles

The MPR, comprising 500 parliamentarians elected in June's national elections and 200 appointed officials, will choose Indonesia's new president in a vote at 0300GMT on Wednesday.

The outcome of the vote, the country's first contested presidential election, remains uncertain.

Megawati Sukarnoputri, whose party won the largest share of the vote in the June election, has failed to build a firm coalition with other parties in the assembly.

Her party, the Indonesian Democratic Party-Struggle, holds the largest block of seats in the assembly, but falls well short of a majority.

General Wiranto says he must concentrate on preserving national security

Recently, moderate Muslim leader Abdurrahman Wahid, previously a key Megawati ally, announced that he would stand against her. He said she would not be included in any government he forms.

A number of Muslim groups have also said that they will not accept a woman as Indonesia's next president.

Nonetheless, opinion polls show that Megawati, daughter of Indonesia's first President, Sukarno, has considerable public support and would easily win if the president was directly elected by ordinary Indonesians.

On Tuesday in a rare interview carried in four Indonesian newspapers, Megawati urged MPR members to back her for the presidency, saying it was the will of the Indonesian people.

"The nation's political elite must put the interest of the people first," the English language Jakarta Post quoted her as saying.

"After all, who holds the sovereignty? The people or the MPR?"

Observers have warned that popular discontent could turn to violence if Megawati fails to win the presidency.