I had diet-controlled GD with DS2 and they kept threatening to induce me (from about 34 weeks) because growth scans showed him to be small.
However, he eventually arrived naturally, two days before they'd have induced me, and at 40+4.
One consultant told me that a waterbirth was out of the question even if I went into labour naturally, but I made him go and check with the head consultant who said it was OK - I'd had a previous waterbirth at the same hospital with no complications and I didn't see any reason why I'd not be able to have one this time round.
The only time they'd have not let me is if I'd been induced or if I'd needed IV insulin.
One thing - if you're planning to breastfeed, ask about expressing colostrum antenatally so that you can give that instead of formula if the baby's blood sugars don't rise quickly enough for the hospital. If you're interested I'll link to my thread about the saga I had with the hospital when DS2 was born and they wanted to give him formula (something I strongly wanted to avoid, and did).
Also, DS2 wasn't a waterbirth in the end, but his birth was a bit easier than DS1's (probably because he was a second baby, admittedly!) - but I just want you to know that even if you don't get a waterbirth, you can still have an excellent birth. Oh, and DS2 was 8lb 1oz, so he was hardly the tiny baby I'd been warned to expect!
Good luck with it. One good thing was that I lost half a stone in the fortnight following my diagnosis with GD so it's not all negative (even though it did feel a bit like it at the time!) 