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The Southern District Health Board announced this afternoon the hospital would become an emergency, diagnosis and transfer centre.
Staff at the hospital and the Queenstown community have been calling for the change for years.
The board's commissioner team said the hospital would be upgraded in two stages.
Deputy commissioner Richard Thomson said the first stage would ensure that the community's immediate needs were attended to.
The emergency department would be reconfigured "to a modern standard" and explore options for a CT scanner and ultrasound services.
A specialist audiovisual suite would also be developed, while some wards, including the maternity ward, would be refurbished.
The DHB statement also mentioned it would "enhance" transport options to and from other centres.
A project manager should be appointed next month and the first stage of the upgrade should be finished in 2018.
Details of the second stage were unclear.
Mr Thomson said a "fuller district-wide discussion" would continue about the longer-term vision for the hospital.
The board said it would need to consider services provided in other areas, including Dunedin and Invercargill.
A Ministry of Health report into ownership options for the hosptial had now been released.
Mr Thomson said: “We note that this recommends continuing DHB ownership due, in large part, to the region’s rapid growth scenario. Our proposals are entirely compatible with this recommendation.”