The £70m YOI at Glen Parva, in Leicester, designed specifically for 15- to 17-year-olds, was due to be up and running by 2012.
Instead a cheaper, equivalent number of adult prison places will be provided on existing prison sites.
Prisons and probation minister Crispin Blunt said the decision was taken due to falling levels of young people in the secure estate – as of March this year there were 2,209 young people in custody, compared to 3,019 in August 2008.
Blunt said: "Meeting the demands of the prison capacity programme more efficiently allows us to play our part in contributing savings to reduce the budget deficit.
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