Plans for a huge commercial development that would transform a tiny town near the edge of the Grand Canyon have been thrown out by federal officials in a surprise victory for conservation and indigenous interests – but campaigners warn that the world famous natural wonder remains in peril.

Tusayan, in northern Arizona, has a few low-key hotels and a population of just 560.

A mile from the entrance to Grand Canyon national park, it is the last settlement tourists pass through, if they even notice it, before entering the park to gawp into the spectacular sandstone abyss.

But an Italian developer has spent more than two decades hovering over this speck on the map with dreams of turning it into a bustling resort area with three million square feet of commercial facilities, including a tourist lodge, spa, cultural center, upscale shops, restaurants, holiday ranch, hotels and a few thousand new homes.

The scheme has caused a long-running, often bitter battle between local civic leaders supporting the developer, the Italian-owned Stilo Development Group USA, and environmental and Native American groups in opposition.

But a milestone decision has sent proponents of the development project reeling.

Heather Provencio, the new supervisor of a nearby chunk of national forest who needs to approve better road access across the federal land for the private development to go ahead, announced the plan was not in the public interest.

Provencio, a former district ranger, wrote to the mayor of Tusayan a week ago, tossing out the plan with the devastating bureaucratic understatement that it “did not meet minimum requirements for initial screening”. That meant it was not even worthy of being given an environmental impact assessment.

Provencio took up her new post as supervisor of the Kaibab national forest near Tusayan last October. She immediately began meeting all parties and considering the more than 200,000 public responses that had come in since the town authorities, in effect working in partnership with Stilo, had applied for improved road access in 2014.

“By November, it was becoming crystal clear that this was a different level of response than I had ever had – and I have worked on controversial projects before,” Provencio said.

The vast majority of the responses were negative, she said.

The Native American Havasupai group that lives at the bottom of the canyon just beyond the boundary of the national park, next to waterfalls tumbling into famed turquoise pools, complained that the vast new development would suck up scarce water resources that sustain their downstream community.

And the national park came out in opposition, indicating that the water supply was already barely able to service its five million annual visitors.

Even without strong lobbying by environmental groups or senior federal government figures, these vital neighbors of the forest held the greatest sway for Provencio.

“We have tribal lands on either side, we have the national park. The wild animals don’t see the boundaries and our policy is to consider all lands,” Provencio said.

She consulted with more senior forest service chiefs and then returned the proposal to Tusayan.

“Before we can even accept a proposal, we need something that has some agreement around it,” she said.

Getting agreement from the Havasupai, the neighboring Hopi Native Americans who were also opposed, and the park will be a tall order, environmental campaigners believe.

But they are still surprised Provencio quickly came out with a firm rejection, when they believe the forest service has a reputation for giving the benefit of the doubt to developers.

Ethan Aumack, conservation director of local advocacy group the Grand Canyon Trust, said: “The federal government came about as close to saying ‘Hell, no’ as it comes. It was very unambiguous and that was surprising.”

He said the national forest service has “rubber stamped” many development proposals similar to this “all across the US”.

He is delighted.

“This is a sign that the Grand Canyon is a national treasure and an international treasure and the forest services recognizes it as such. This development was too close, too large and too thirsty,” he said. “I hope this decision is the beginning of a trend where citizens, government officials and land managers work together to protect such places.”

Eric Duthie, the town manager of Tusayan, also said he was surprised by Provencio’s decision, though not pleased.

“We had been given assurances that it was moving to environmental assessment. This decision was just astounding,” he said.

Duthie and the town mayor Craig Sanderson, to whom Provencio wrote her letter, desperately want a developer to build affordable housing in the town, as almost all residents currently live in employer-controlled housing owned by the park, the forest service or related agencies.

Duthie said any concerns about the larger development could be addressed if the forest service would allow the proposals to be assessed fully.

Stilo issued a statement saying it was surprised and disappointed by Provencio’s decision and was considering its next move.

In addition to the Stilo project, a proposal to build a large development and run a gondola service into the canyon from Navajo land is also on hold.

But the Grand Canyon faces several more imminent threats.

Further arguments are expected in a federal appeals court over a lawsuit from the National Mining Association challenging the 20-year ban on new uranium mining close to the Grand Canyon, imposed by the Obama administration in 2012. The attorneys general of Arizona and Utah have filed briefs in the case in support of the mining industry.

Opponents of uranium exploitation in the area argue that mining uses scarce water for its operation and then contaminates ground water with its waste that will inevitably seep into the canyon.

If the government loses the case, mining companies are expected to close in on the canyon. The next president might also undo the ban.

And the canyon continues to suffer from the regional scourge of prolonged drought and chronic over-consumption of water that has been draining the Colorado River, which flows through the canyon and into the depleted Lake Mead.

“The Grand Canyon has been under siege for decades from a number of threats and it continues to be. We can’t let our guard down,” said Aumack.