Mahmoud Ahmadinejad inaugurated the project and toured the site at Khondab, which is near Arak, 190km southwest of the capital Tehran.
The plant's plutonium by-product could be used to make atomic warheads.
The move comes days before a UN deadline for Iran to halt uranium enrichment, the part of the programme which is the biggest worry to the West, and is likely to raise further fears in Western capitals.
"Inaugurating the heavy water production plant in Arak is a big step towards using Iran's right, which means reaching peaceful nuclear technology," Hamid Reza Asefi, a foreign ministry spokesman, was quoted by state television as saying.
An Iranian nuclear official said this week that heavy water production itself was not a proliferation risk but a Western diplomat said such a move would not be a constructive step.
Western nations accuse Iran of seeking to master technology to produce nuclear weapons. Iran, the world's fourth largest oil exporter, says its aim is only for electricity and that it has no plans to build atomic weapons.
Iran's highest authority, Supreme Leader Ayatollah Ali Khamenei, issued a religious decree last year, saying that making, stockpiling or using nuclear weapons was against Islamic beliefs.
The Khondab complex is protected by dozens of anti-aircraft guns and surrounded by a four-metre high barbed wire fence.
The Iranian nuclear official had said Iran would start up heavy-water production but not the reactor. He said the unit had no military use so supervision by the UN's International Atomic Energy Agency (IAEA), was not obligatory.
"Be afraid of the day that the Iranian nation comes into the streets and stages demonstrations to ask the government to produce nuclear weapons to combat the threats"
Mohammad Reza Bahonar, deputy parliament speaker
"The product of this project provides for cooling and depleting systems of the reactor, that can be used in various industries," the official said.
The UN Security Council passed a resolution on July 31 giving Iran 30 days to halt enrichment or face possible sanctions.
The resolution also cited a call by the IAEA for Iran to reconsider construction of its heavy water reactor project.
Mohammad Reza Bahonar, Iran's deputy parliament speaker, warned the West in comments published by Iran's Sharq newspaper on Saturday that putting pressure on the country could prompt public calls for Iran to pursue a weapons programme.
"Be afraid of the day that the Iranian nation comes into the streets and stages demonstrations to ask the government to produce nuclear weapons to combat the threats," he said.