The Senate of Australian Parliament on Thursday rejected the government's proposal to lift the debt ceiling to 500 billion AU dollars (468 billion U.S. dollars).
Labor and the Greens voted to amend the government's debt ceiling legislation to cap borrowing at 400 billion (374.2 billion U.S. dollars), rejecting threatened government spending cuts.
The amended debt ceiling bill will now return to the government- dominated House of Representatives, where the government can accept the new limit or continue to fight for the higher cap.
The current 300 billion (280.7 billion U.S. dollars) limit will be breached on December 12.
Treasury said in its pre-election budget update that government debt would peak at 370 billion AU dollars (346.2 billion U.S. dollars) in 2015/16. The new 400 billion limit will be sufficient to cover borrowing into next year, but the government says debt will peak higher.
Treasurer Joe Hockey has warned that he will "stare down" Labor and the Greens, raising the prospect of a U.S.-style government shutdown if the opposition parties refuse to raise the debt limit from 300 billion to 500 billion.
But opposition treasury spokesman Chris Bowen said the government had come "nowhere near close" to justifying its proposed increase.
"We have taken a reasonable approach," Bowen said.
"We are more than happy to vote for a debt limit increase and we have, of 100 billion dollars - not a small amount, a very significant amount."
He said if the government needed more than 400 billion, it should return to the parliament, asking for a raise in the limit following its mid-year "mini-budget" showing the impact of post- election spending decisions.