Universities Secretary David Willetts provoked fury last night when he revealed that students studying privately would be given access to Government loans and grants.
Lecturers' leaders warned the move would help private education providers cut their fees at a time when state-funded universities were struggling with budget cuts.
Mr Willetts delivered his message as part of a two-pronged warning to universities not to stampede to set the maximum £9,000-a-year tuition fee when charges rise next year.
He told vice-chancellors that they would face further cuts in spending if too many opted for the highest figure.
He then warned they would face increased competition from private-sector providers of degree courses – effectively undercutting them if they plumped for the highest fee option.
Labour and lecturers' leaders saw the move as a desperate attempt to deter too many universities from opting for the maximum fee.
The University and College Union said the Government was wrong to allow private education providers access to taxpayers' money to keep their fees down.
Mr Willetts told a meeting of Universities UK – the body which represents vice-chancellors – that ministers would have to consider further cuts if the average fee was more than £7,500. That was the loan level the Treasury had budgeted for. "So your own actions further increase your risk," he said, "and none of us want to see that happen."