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Figures show 564 students - 20% of the university's New Zealand postgraduate students - would be affected by the change when it takes effect next year.
Otago University deputy vice-chancellor, research and enterprise, Prof Richard Blaikie said the university had raised its concern with the Government after receiving figures in the past week from StudyLink.
The figures projected 155 doctoral students, 305 master's students and 104 other postgraduate students at the university would not be eligible for the allowance next year.
The changes were announced by Minister for Tertiary Education Steven Joyce in this year's Budget.
Prof Blaikie said this represented a "significant proportion" of its about 4000 postgraduate students.
International students do not receive allowances.
"There is concern that this will mean that fewer students will be choosing to undertake postgraduate here at the University of Otago, as would be the case [at other institutions in New Zealand]," he said.
Postgraduate students were "very important" to the university.
It "may be difficult" to increase the level of scholarships to help fill the gap left by the decision to cut allowances. The university already invested "more than $20 million" a year in scholarships.
The university had only just begun discussions with the Government and ministry officials about its concerns and Prof Blaikie said he could not comment on its desired outcomes from the discussions "at this stage".
The concern from the university comes as the Ministry of Social Development (MSD) released figures to the Otago Daily Times under the Official Information Act showing more than 4441 postgraduate students received the student allowance last year.
The region with the largest number of postgraduate students receiving the allowance was Auckland (2022), followed by Canterbury (653), Wellington (596) and Otago (506).
MSD also provided figures showing more than 560 students last year received the allowance beyond the 200-week cut-off point after applying for an exemption, which is due to be axed next year.
Of that number, 74 were in Otago.
Otago University Students' Association (OUSA) president Logan Edgar said he was surprised by the number of students affected by the changes.
The policy change conflicted with the Government's aims to increase the economic benefit from research, as much of the impetus for this research came from postgraduate students, he said.
A spokesman for Mr Joyce said the policy was not intended to discourage postgraduate study and most students affected would be eligible for an interest-free student loan for their living costs.