"Both parties [the ruling Zanu-PF and the opposition MDC] must realise that this country is burning and the only way is to sit down and find a way out of it," he told reporters on Wednesday in Harare, the Zimbabwean capital.
Tsvangirai said a transitional period was in the interest of the Zimbabwean people who were being "brutalised" by militias affiliated with President Robert Mugabe.
He led Mugabe in first-round presidential election held on March 29, but he did not enough votes to secure an outright victory, necessitating the run-off vote.
Tsvangirai withdrew from the election on Monday citing violence against his supporters as a major reason for his decision.
On Wednesday, Tsvangirai briefly left the Dutch embassy in Harare, where he had taken refuge, to address a news conference.
He returned to the embassy later, having earlier said he feared for his life.
Hundreds of his supporters have also taken shelter in the South African embassy, fearing attacks by ruling Zanu-PF men.
Advocating a transitional phase for division-ridden Zimbabwe, Tsvangirai, speaking to Al Jazeera after the news conference, said: "We are making this proposal which Mugabe has the choice to accept or not, and I am sure that Zimbabweans want a negotiated way out of the crisis.
"You cannot have an election when negotiations are taking place," he said.
Tsvangirai said key issues needed to be dealt with before Zimbabwe could return to normalcy.
They included an end to violence, the safe passage of humanitarian assistance, and the release of political prisoners.
But while seeking a negotiated settlement, Tsvangirai said there could be no discussions without the release of Tendai Biti, the MDC secretary-general.
Biti, currently in detention, has been charged with treason and faces a possible death sentence.
"He must be released immediately," Tsvangirai said.
When asked about the fact that some of his supporters felt let down by his pulling out of the presidential run-off, Tsvangirai said: "I cannot move around the country. Everything is being placed in my way when I try to campaign.
"We are not afraid of going into an election... [but] this is not an election, this is war."
The MDC says that at least 80 of its supporters have been killed by Zanu-PF loyalists and another 200,000 people have been displaced in what it calls Mugabe's "campaign of intimidation" to deter people from voting.
Mugabe supporters have denied the allegations.
Haru Mutasa, Al Jazeera's correspondent in Harare, said that Tsvangirai's proposal seemed to leave everything to the outside world, whereas Mugabe said this was a Zimbabwean problem that needed a Zimbabwean solution.
On a visit to London, Nelson Mandela, the former South African president, expressed concern over the Zimbabwean crisis and criticised what he said was a "tragic failure of leadership" in Zimbabwe.
|The MDC says that at least 80 of its supporters have been killed by Zanu-PF loyalists [AFP]
Meanwhile, Britain's Queen Elizabeth II has stripped Mugabe of an honorary knighthood awarded to him in 1994, the British foreign ministry has said.
"This action has been taken as a mark of revulsion at the abuse of human rights and abject disregard for the democratic process in Zimbabwe over which President Mugabe has presided," a spokesman said.
The United Kingdom also said it was preparing tougher sanctions against specific members of the Zimbabwean government and urged world leaders to work together to remove Mugabe from power.
Gordon Brown, the UK prime minister, said: "We are preparing intensified sanctions, financial and travel sanctions, against named members of the Mugabe regime."
He said the way forward for the country was by the UN and the AU "working together for a change of regime".
The England and Wales Cricket Board (ECB) has suspended Zimababwe's tour of England in May next year after discussions with Cricket Zimbabwe on Wednesday.
In a statement, the ECB said that the UK government had given it "a clear instruction that Zimbabwe's bilateral tour scheduled under the International Cricket Council Future Tours Programme for 2009 should be cancelled".