The Port Fairy to Warrnnambool Rail Trail has missed out on funding of $1 million, which was to be used to upgrade the facility.
Moyne Shire Council presented an application to the state government for the grant but was informed its best efforts had fallen short.
Moyne Director of Community and Corporate Services, Kevin Leddin, said the government told council it had been oversubscribed with grant applications.
"We did however receive glowing feedback on the calibre of the application for the rail trail upgrade," Mr Leddin said.
"We will draw on this feedback for inspiration and confidence when applying for future grants."
Port Fairy to Warrnambool Rail Trail committee of management secretary Ian Bodycoat said the funding knock back was a blow.
"I'm disappointed the funding didn't get approved," Mr Bodycoat said.
"Both Moyne Shire Council and the rail trail committee of management put a lot of work into the funding submission. Hopefully more funding opportunities will present themselves and we will still be able to secure the money that is needed."
While Mr Bodycoat praised council for its funding application, he was disappointed the losing bid did not trigger an increase in Moyne's annual $25,000 contribution to rail trail maintenance.
He said a boost in funding was needed as the rail trail approached a significant junction in its history.
"It would have been nice if Moyne had bumped up its contribution," Mr Bodycoat said.
"We are getting more and more complaints about the trial and how rough it is in places. It has been in use for 10 years now and it is showing wear and tear.
"The trail needs some significant love and for that money needs to be put into it."
Mr Bodycoat said his committee had a plan on how to best proceed with a track upgrade.
"We would like a significant amount from council, $50,000, and our aim would be to upgrade a section of the trail to the standard it needs," he said.
"That would then show us how far that would take us and from there we could calculate what the cost would be for the whole project.
"There are sections of the trail that need a lot of work but also some that are in great condition and wouldn't need to be touched."
The first sod on the rail trail was turned in 2008 and within two years it was in use, with the official opening in 2012.
Since then, the trail has grown in popularity, with numbers now at an all-time high.
The counter mounted at the Koroit Railway Station shows up to 6000 people are using the trail each month.
The the rail trail committee of management maintain the trail from Port Fairy to the Princes Highway in Illowa.
From there to Spooky's Beach is under the watch of Moyne Shire Council.
Warrnambool City Council take over from there to the city's foreshore precinct. Warrnambool City allocates $28,112 to maintenance of the trail.