The Cabinet has approved funding for the construction of a 60-bed container unit at Rimutaka Prison in Upper Hutt, north of Wellington.
The unit will be for high and medium security prisoners and will contain a mixture of single and double bunk cells.
Corrections Department chief executive Barry Matthews says the tender process for the construction of the unit will begin within a month and the new unit will be in use by March 2010.
Mr Matthews says the prison population will reach its maximum capacity by February next year, which highlights the need for more double-bunking.
The department will check that prisoners are compatible before putting them in cells together, he says.