BBC correspondent James Reynolds says that Juan Guzman, the judge investigating the charges against the general, had previously dismissed attempts by the defence to have him declared unfit for trial.
General Pinochet, aged 85, was charged as an accessory to 75 cases of politically motivated kidnapping and murder carried out at the beginning of his 1973-90 rule.
Technically, the process has been delayed until his condition improves, but given his age this is unlikely to happen.
BBC correspondent James Reynolds says that Juan Guzman, the judge investigating the charges against the general, had previously dismissed attempts by the defence to have him declared unfit for trial.
But, he says, the panel which made Monday's decision had declared him unfit on the basis of the same report that Judge Guzman had seen.
The general's mental condition was also cited as the reason for allowing him to return home last year from Britain, where he had been detained after a request for his extradition by a judge in Spain on similar human rights charges.
Disappointment
The general's lawyer told reporters outside the courtroom that he was very satisfied with the decision.
But prosecution lawyers said they would seek a reversal of the ruling.
Viviana Diaz, president of the Association of Relatives of Disappeared Persons, told Spanish radio the decision was "shameful" and "incredible".
"Once again the country is being lied to; once again, justice is not being done in our country," she said.
Human rights lawyers in Spain who originally sought to bring General Pinochet to court said the ruling was a blow against efforts to end his impunity.
And Amnesty International spokeswoman Virginia Shoppee said it was a shame the authorities had not been able to find answers for the victims' relatives.
'Stable condition'
On Sunday, a spokesman for General Pinochet said that he was in a stable condition two days after being discharged from hospital.
And the general's older son, Augusto Pinochet Hiriart, said that there was no danger of his imminent death.
General Pinochet is accused of covering up dozens of killings and abductions by an army squad known as the Caravan of Death after he came to power in a coup in 1973.
His opponents say he had a clear responsibility for the slaughter, sending a close associate to head the squad. He has repeatedly denied any responsibility.
The charges are among the more than 250 complaints filed against him for alleged human rights abuses during his 17-year rule, when more than 3,000 people were executed or disappeared presumed dead.
If convicted, he could have been sentenced to up to five years in jail.