The deal comes just days after veteran fly-half Eric Elwood was installed as Connacht's new assistant coach.
The 24-year-old Downey had been earmarked by Narbonne RC as a potential signing after impressing against them in the sides' European Challenge Cup first round clashes last autumn.
Indeed, officials from the south of France club were present at the Sportsground earlier this month to watch Downey in Connacht's narrow semi-final first leg loss to Sale.
Downey, at 6' 4", put in a number of towering performances at inside centre this season - not least when he went under the posts in Grenoble in January as Connacht earned a famous 26-21 away win against Dean Richards' men.
Connact CEO Jerry Kelly said: "We were aware that Narbonne were interested but we are delighted that James has decided to remain with Connacht.
"James has had a great first season and there is strong hope that, along with a few other Connacht players, he will be travelling to Japan with the Irish squad this summer."
The Ireland travelling party for June's Far East excursion is due to be finalised in the coming weeks.