Former interior minister Gideon Saar's decision comes after the Likud central committee approved Netanyahu's proposal to bring forward the party primaries by a week, making it more difficult for him to mount a campaign.
Saar, considered the only real potential challenger to Netanyahu, said on Facebook that, "under the circumstances created and after serious deliberation, I've decided not to run for the Likud leadership at this stage."
The ambitious Saar had surprised the political establishment in September when he announced he was quitting politics to spend more time with his family.
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Speculation over his possible return to political life has been rife since Netanyahu called earlier this month for snap elections.
Shortly after Saar announcement Thursday, Netanyahu defined the key issue of the March 17 vote.
"The upcoming elections are about one question only -- who will lead the country? Leftwing candidates, whose numbers keep rising, or a strong and broad Likud government led by me," he asked activists at party headquarters in Tel Aviv.
Opposition Labour party leader Isaac Herzog and centrist former justice minister Tzipi Livni announced Wednesday an alliance aimed at defeating Netanyahu's "extreme right" party in the upcoming vote. Opinion polls are showing that the new alliance could get more votes than Likud.