The announcement caught analysts by surprise and brought ratings downgrades for Proton stock as questions grew over the long-term viability of loss-making automaker.
Talks were called off after intense lobbying by Proton's management who wanted a chance to turn the company around, as well as some of Proton's rivals, according to a source familiar with the talks told Reuters.
Rival firms had feared a Volkswagen-Proton alliance would usher in fierce new competition into the Malaysian domestic market.
Explaining the decision to terminate talks with potential partners, Nor Mohamed Yakcop, Malaysia's second finance minister, said the government felt Proton should be given a chance to return to profitability on its own steam.
He said the company had shown strong sales of its latest model and had plans to export to Iran and China.
The government has been in on-and-off talks since 2004 with VW over a possible alliance, hoping to repeat the success Europe's biggest carmaker brought to Czech carmaker Skoda Auto.