The Department of Conservation has revoked the protected status of 22 hectares of Ruahine Forest Park in Hawke's Bay to enable the Ruataniwha Dam to be built.
The DoC land has specific habitats for a range of threatened species, including the long-tailed bat and New Zealand falcon.
DoC director general Lou Sanson said the land would be exchanged for a larger block of 170 hectares of beech forest and regenerating bush.
Mr Sanson said he approved the land exchange with the Hawke's Bay Regional Council's investment company because it would mean a net gain for conservation.
Hawke's Bay regional councillor Tom Belford earlier said the council's investment company HBRIC was avoiding talking about the DoC land but it had huge implications for the dam project.
"I've been told if that land is not available it could compromise as much as half the planned capacity of this reservoir. Even if that is overstated by twice, it's still a very significant dent in the carrying capacity of this reservoir and it would require all of the economics of this to be totally reassessed from the ground up as to the viability of the project."
Mr Belford said if the protected land was deregistered then legal action would probably follow that could hold the Ruataniwha Dam project up for months.