Falmouth Bay is one of England's finest stretches of marine habitat, with a profusion of creeks that penetrate deep into the heart of the Cornish countryside, and oak woods covering the coastline. It is a distinctive, unspoiled landscape, protected by strict environmental legislation and enjoyed by thousands of tourists every summer.

But the tranquillity of Falmouth could soon be disrupted. A controversial plan to dredge a channel through part of the bay to open up the port to giant cruise ships has caused consternation among conservationists. They say the proposal could devastate the bay, in particular its beds of maerl, a coral-like algae that provides homes for a variety of sea creatures that includes crabs and scallops. This view has been backed by the Marine Management Organisation which has so far blocked the dredging plan.

The plan's supporters continue to press for action, however. They say dredging will cause little environmental damage and is crucial to a £100m port development for Falmouth that will bring hundreds of jobs to the south-west, a region badly hit by the recession. And the group has powerful backing.

In November the chancellor, George Osborne, picked on the refusal to give the go-ahead to the Falmouth project as an example of the "gold-plating of EU rules on things like habitats" that was placing ridiculous costs on British business. He urged the project's approval and set up a government review of how EU directives on habitats and birds are being applied in England. Its specific remit is to reduce environmental "burdens on business". Many conservationists fear this review, to be published in March, could lead to a dangerous relaxation of rules governing EU protection of other UK habitats.

The bid to dredge Falmouth Bay is, therefore, being watched closely. "If this project is allowed to go ahead, that could set an appalling precedent for all the other protected sites we have in the UK," said Tom Hardy, a marine conservation officer with the Cornwall Wildlife Trust which opposes the Falmouth dredging plan. "Britain's marine environment is woefully poorly protected as it is. This could open it up to all sorts of new developments justified on economic needs. It is very worrying."

Other concerned groups include the RSPB which says that slackening the rules protecting Falmouth Bay could lead to other destructive projects being approved. These include plans to develop the Humber Estuary, build an island airport in the Thames and construct a tidal barrage power plant in the Severn.

Those who back the Falmouth development plan insist the environmental issues raised by the plan have no implications for the rest of the UK. "The harbour waters in Falmouth are slowly silting up," said Captain Mark Sansom, the Falmouth Harbour Master, who has led the port development plan.

"At present, the waters there are about 5m deep at low tide. We want to dredge to make a channel that is 8.5m deep. That would allow really big cruise ships to moor at our docks. Passengers could disembark easily and enjoy trips to Land's End, Padstow and the Eden Project. Cruise companies are keen to add Falmouth to their list of UK destinations. It would be good for business in Cornwall. In addition, big ships would be able to get into our repair yards. Again that would be good for the local economy."

Last year, about 22,000 passengers – from small to medium-sized cruise ships that can still get into Falmouth docks – visited the town. Some took coach tours to other Cornish destinations. Others thronged to visit shops selling local art and tourist goods. "If we can get the really big cruise ships in then we will get 100,000 a year into the town," added Sansom. "Many of these visitors will be German or American tourists with a lot of money to spend."

Dredging the harbour will also be accompanied by new dock construction and the building of a marina at Falmouth, according to the development plan. However, its backers insist that these other proposals depend completely on the deepening of the harbour waters. "This project could bring up to 800 extra jobs to Falmouth and also protect the 450 existing jobs here," added Sansom.

The project's key drawback lies with the fact that the proposed channel cuts through some of the bay's maerl beds. "Maerl is a form of seaweed that dies, calcifies and forms layers that have nooks and hollows in which all sorts of sea creatures – including juvenile fish and shellfish – make their homes," said Hardy. "It is an extremely important habitat and an economically valuable one. These beds are nurseries for crabs and scallops, for example."

The maerl beds at Falmouth were a key factor in designating the bay a Special Area of Conservation under the EU Habitats Directive. As a result, when Falmouth Harbour Commissioners applied to dredge the channel they were turned down by the Marine Management Organisation – even though the new channel would affect only 2% of the bay's maerl beds. The decision dismayed many local businessmen.

"The environmental consequences have, to date, been the only ones considered by decision makers. That upsets me," said Pete Fraser, owner of Falmouth's Harbour Lights fish and chip restaurant. "We live in extremely challenging economic times, and the proposed dredging would be a massive boost to the struggling Cornish economy."

Others disagree. "The material dredged up to make the channel would be dumped in another part of Falmouth Bay, right on top of one of our best fishing grounds," said fisherman Chris Bean. "We get lots of really good quality cod, haddock, whiting and pollock there. The bay's fishing grounds would be ruined if dredging went ahead."

At present, the channel plan remains on hold. However, a project by Plymouth University scientists – set to begin in April – will attempt to discover if the harbour's maerl beds could be relocated in the bay without causing major disruption to the sea creatures who make homes in them. If the plan is feasible, the MMO could very well relent and approve the project. However, if the maerl relocation plan is rated a non-starter by the scientists, then the project will remain on hold – until the habitat directives review is completed by the Department for Environment, Food and Rural Affairs.

By slackening how the EU habitat directive is implemented, and giving business more influence over the outcome, the goverment could allow the Falmouth dredging – and many other projects – to proceed. "This could be the thin end of the wedge," added Tom Hardy. "It won't just be Falmouth dock development that gets the go-ahead but a lot of other unpleasant projects."