The drug, Orkambi, is made by manufacturer Vertex and is the first available that treats the faulty proteins typical of cystic fibrosis sufferers.
Doctors say the drug is one of the most effective medicines available to reverse the impacts of the disease, but Australia's Health Department says the drug is too expensive and its benefits are not clear.
Trials were conducted at nine clinics in Australia before the Australian Pharmaceutical Benefits Advisory Committee considered subsidising the drug.
The trials showed an average 40 per cent reduction in lung damage and a three per cent improvement in lung function in patients.
The Director of Respiratory and Sleep Medicine at the Royal Children’s Hospital in Melbourne, Dr Sarath Ranganathan, said: “What's unique about this drug is that it's the first that actually modifies the actual pathophysiology, the actual disease processes in this condition."
“All the other drugs and treatments that we use are actually designed to minimise the symptoms that people experience," he said.
On Friday, the Pharmaceutical Benefits Scheme website published its reasons for rejecting the drug, stating “there was no statistically significant difference in the quality of life measure".
It also noted the net cost to the Australian Government of subsidising the drug “was more than $100 million in each of the first five years of listing” and therefore “at the requested price, the requested listing for lumacaftor/ivacaftor (Orkambi ingredients) was not sufficiently cost-effective to enable PBAC recommendation for PBS listing".
The news was a major blow for Australia’s 3000 cystic fibrosis sufferers, half of which could benefit from the drug.
Nettie Burke, CEO Cystic Fibrosis Australia, said they were devastated.
"Cystic Fibrosis Australia and the CF community are devastated," she said.
"We're going to keep fighting because people with CF need Orkambi.”
Brisbane sufferer Jessica Bean, 28, participated in the Australian trials and noticed her lung function improve within a day.
Ms Bean said the drug turned her life around.
“My therapy has reduced from up to six hours to between one and two hours a day and I'm no longer spending up to six months in hospital,” she said.
Reacting to today’s announcement, Ms Bean said the fight was far from over.
“I’ve had friends who have passed away waiting for Orkambi” she said.
Cystic Fibrosis is caused by a genetic mutation affecting proteins that usually transport salt in the body, leading to a buildup of sticky mucus and chronic infections - and sometimes, respiratory failure.
Australia's decision on Orkambi mirrors that of the United Kingdom where the Government also ruled it was too expensive, but the United States approved the medication for its scheme.
Drug manufacturer Vertex said it was disappointed with the PBAC’s decision.
“Today’s outcome demonstrates the difficulties of developing and assessing medicines for small patient populations,” Vertex spokeswoman Megan Goulart said.