President Shimon Peres is expected to ask Netanyahu to attempt to form a new government. His Likud-Beitenu alliance lost a quarter of its seats in parliament, but remains the largest grouping with 31.
Netanyahu, 63, has offered to work with the newly-formed Yesh Atid (There is Future) party led by Yair Lapid, which shocked observers by coming second with 19 seats.
Lapid, a 49-year-old former scribe had joined the political race only last year by forming the Yesh Atid party, which has emerged as the kingmaker.
He is expected to play an important role in the formation of the next government.
The unexpected results have forced the 63-year-old Netanyahu to scramble for support outside his natural allies which critics feel augurs well for the West Asian peace process that he shunned during his last four years.