Environment Minister Greg Hunt said approval for Indian firm Adani's Aus$16.5 billion (US$15.5 billion) Carmichael coal mine and rail project in Queensland state was subject to 36 conditions.
"The absolute strictest of conditions have been imposed to ensure the protection of the environment, with a specific focus on the protection of groundwater," he said in a statement.
The development proposes open-cut and underground coal mining some 160 kilometres (100 miles) northwest of Clermont in central Queensland, as well as a 189-kilometre rail link.
It is forecast to produce 60 million tonnes of thermal coal a year for export.
State officials say the project, which could potentially be the largest coal mine in Australia and one of the largest in the world, will play a major role in opening up Queensland's resource-rich Galilee Basin.
It is also expected to contribute Aus$2.97 billion to the Queensland economy each year and generate thousands of jobs.
"It is estimated the project will provide electricity for up to 100 million people in India," Hunt said.
Australia's exports are heavily dependent on mining, and Trade Minister Andrew Robb said the project demonstrated the potential for the resources sector to drive economic growth.
"It will help support the opening of Australia's first new mineral province in 40 years," Robb said, adding that the commitment from major global company Adani was a welcome foreign investment.
- Environmental concerns -
But conservationists criticised the approval of a project which plans to ship the coal from the mine through Abbot Point on the Great Barrier Reef coast.
Adani won approval for a major coal port expansion at Abbot Point in December which allows it to dredge three million cubic metres of material from the seabed so freighters can dock.
Ben Pearson from Greenpeace Australia Pacific said the decision to approve the "monster mine" given concerns about climate change was appalling.
"You can't ignore the fact that it is also a mine which, if it went ahead, would impact on the Great Barrier Reef World Heritage area and that's because of course to get that coal out you have to build a new coal export terminal at Abbot Point," he said.
The Australian Conservation Foundation said the approval was "bad news for water resources, wildlife and the global effort to tackle climate change".
The project would also take billions of litres of water from underground aquifers, creating problems for farmers, and destroy part of the remaining habitat of the endangered black-throated finch, it said.
"While some of the conditions imposed by the environment minister are welcome, they cannot stop this mine from being an environmental disaster," said campaigner Ruchira Talukdar.
Hunt said his conditions complemented those imposed by the Queensland government, and would ensure the developers met the highest environmental standards and that all impacts were "avoided, mitigated or offset".
The state government has established 190 conditions to protect landholders, flora, groundwater resources and air quality, as well as controls on dust and noise during construction and operation.
But Australian Greens Senator Larissa Waters said the decision by the government, which recently repealed the carbon tax levy on the nation's heaviest polluters, was an environmental disaster.
"Australia should be leading the way on renewable energy rather than condemning India to worse air quality and subjecting the world to more extreme weather disasters," she said.