The Interior and Agriculture departments yesterday approved a controversial Denver water project which environmentalists opoosed and saw as a test of the administration's up-coming water policy.

The project has been strongly contested by the government's two main environmental agencies, the Council on Environmental Quality and the Environmental Protection Agency, which contend it would aggravate air pollutionand destroy any incentive for water conservation.

Interior, which issued the permit for Denver to build a large dam and water treatment complex, sought to meet environmental concerns by warning the city it must start conserving water if it wants to expand water supplies in the future.

But some environmentalists still saw the Denver permit as a sign the administration is backing off President Carter's promise last year of "comprehensive reform of water resources policy with conservation as its cornerstone."

"The cornerstone has turned to soapstone," one critic said yesterday.

However, Interior Secretary Cecil D. Andrus does not view the so-called Foothills complex as a test of the water policy he has presented to Carter. "in the secretary's view this is a regional and local matter," an Interior spokesman said.

Denver applied to build a 500-million-gallon-a-day plant to double the city's treatment capacity. The plant needed rights of way over 100 asres of Forest Service and Interior Department land. For the past four years, environmentalists have waged a court battle to stop the granting of the federal permit.

The city claims the plant is needed to meet peak summer water demands. But environmentalists contend the demand can be met by water conservation -- metering Denver's homes, increasing the price of water and staggering lawn watering days in summer.

If the treatment plant is built, they say, it will require the construction of more dams and reservoirs and the importing of water across the Rocky Mountains from Colorado -- the kind of large watee projects Carter has said he opposes.

However, Interior said yesterday it will require that the city implement "an effective water conservation program with definite goals and time schedules" before it grants any permits for future water supplies.

Denver attorney John R. Bermingham, head of the Water Users Alliance which has been fighting Foothills, said the federal decision was "based on the political realities. The administration wants to get [Sen. Floyd] Haskell and [Gov. Richard] Lamm reelected. There would have been a backlash against federal interference.%

Another Denver environmentalist, Robert Weaver of Trout Unlimited, called the decision "ironic because a conservation in the future "is too little, too late," he said.

At a Denver press conference, Interior official Dale Andrus (no relation) dismised EPA's concern that the treatment plant would encourage growth in a city with one of the worst air pollution problems in the nation.

"We should not dictate air quality standards," he said. "It's not our. (Growth) is not our resonsibility." City officials say Denver's projected growth -- from the present 1.5 million to 2.35 million in the year 2000 -- is inevitable and should not be limited by water supply.

The Foothills controversy placed Sen. Gary Hart (D-Colo.), known as a leading Senate environmentalist, in the unusual position of opposing environmentalists. When CEO announced its opposition Friday, Hart engaged in what one federal official called "arm twisting" by calling Secretary Andrus, CEW member Gus Speth and Agriculture Secretary Bob Bergland.

Hart said, however, that he was not exercising "political pressure -- that's not my style. I talked to them by way of questioning." He said he favors but with thedam in a different location.