The President's eagerly-awaited decision will be warmly welcomed in the West, and particularly in the United States, where senators had voted to withhold about $200m (pounds 120m) in aid to Russia if he signed it. The bill, "On Freedom of Conscience and Religious Associations", placed Mr Yeltsin in the politically painful position of having to weigh the considerable damage it would do to Russia abroad against huge domestic conservative pressures.
It was opposed by the Pope, who wrote to Mr Yeltsin requesting him to withhold his signature, warning that it threatened the survival of the Roman Catholic Church in Russia.
Announcing what he described as a "difficult decision", the President said it would have restricted the constitutional rights of Russians, destroyed the equal rights of different religions, and "contradicted" Russia's "international obligations". He also said it could "trigger religious strife" within Russia.
The legislation, overwhelmingly supported by both houses of parliament, placed restrictions on new "non-traditional" religions in Russia, which is dominated by Orthodox Christianity, but also recognises Islam, Buddhism and Judaism as part of its heritage.
Its overt intention was to stamp out the increasingly popular quasi-religious cults, like the Japanese Aum Shinri Kyo sect, masterminds of the nerve gas attack on a Tokyo subway in 1995. But it also swept in the Roman Catholic Church - which has long been at loggerheads with Russian Orthodoxy - and other mainstream groups, such as the Baptists.
Among other clauses, it includes imposing a waiting period of 15 years before allowing religious organisations full legal rights - which would have barred them from owning property and worshipping during that period. Mr Yeltsin now faces the prospect of a row with parliament, which will accuse him of pandering to the West and especially the US.
The legislature, with whom he has long been sparring, can override his veto with a two-thirds majority vote in both chambers - a figure it currently appears capable of mustering.The issue must now wait until after parliament's summer recess, which ends in September.
Mr Yeltsin has never been particularly religious, but he has forged a close bond with the Orthodox Church, which is widely seen as symbolic of Russia's imperial past and its aspirations to achieve greatness again.
Church leaders have long worked hand-in-hand with the state (including with the KGB under Communism).
However, yesterday's events mean that the relationship is now under pressure. The Russian Patriarch, Alexy II, was a firm advocate of the proposed laws, describing the growth of foreign cults in Russia as a Western invasion.
The Russian Orthodox Church clearly had other motives: it has long complained about rivalry from outsiders, notably the Catholics, whom it accuses of proselytising in Russia. So strained are relations that plans for the first ever meeting between the Pope and the Patriarch were recently cancelled.
The President's decision which, like many sensitive issues in Russia, was not announced until 9pm at night, brings a temporary halt to a tortured conflict which had set conservatives and the church against human rights advocates and the WestReuse content