* Govt seen defending zloty by exchanging EU funds
* Strong PLN helps govt to improve debt indicator
* Authorities want to avoid sharp zloty rise in 2011
By Dagmara Leszkowicz
WARSAW, Nov 26 (Reuters) - Polish authorities are using state-owned BGK bank to sell euros to help keep the zloty strong until the end of the year in order to avoid breaching key debt levels, dealers and economists say.
Almost one quarter of a total debt load estimated at 762 billion zlotys ($256 billion) in 2010 is kept in foreign currencies, which makes the final fixing of the year important as this determines recalculations into zlotys.
Under Polish law, if public debt breaches 55 percent of gross domestic product (GDP), the government is required to make painful spending cuts, a scenario it especially wants to avert before parliamentary elections due next autumn.
The zloty weakened significantly on Friday on fears of contagion from the euro zone's debt crisis, bringing the prospect of more action by the authorities to stabilise it ever closer.
"2010 will end with public debt very close to the 55 percent precautionary public debt threshold, potentially forcing politically disastrous tightening decisions in an election year," said Rafal Benecki, senior economist at ING bank.
"Hence the finance ministry will want to keep the zloty strong, thereby reducing the zloty value of its foreign debt."
Public debt stood at 49.8 percent of GDP in 2009, up from 44.8 percent in 2007.
Dealers said BGK was actively buying zlotys for euros.
"I have seen the bank (in the market) more often recently," said one Warsaw-based dealer, who asked not to be named.
"KILLING TWO BIRDS"
Echoing this, a second dealer said a recent weakening of the zloty caused by the latest crisis engulfing the euro zone had provided an opportunity for the government to exchange European Union funds through the spot market at a good price.
"The finance ministry is just killing two birds with one stone. On the one hand, they have to exchange those funds to get money for infrastructure projects, on the other hand it's good timing as the recent euro zone crisis is weighing on the currency heavily," the dealer said.
"Of course, if London names enter the market, Polish players are too small to alter a trend. But BGK's presence on the spot market has a psychological effect as it raises the question whether it is there on behalf of the finance ministry."
As of the end of October, the finance ministry had a total of 6.66 billion euros at its disposal, including EU funds earmarked for road building and other infrastructure projects.
A firmer zloty would also suit Poland's central bank by providing more leeway to defer an expected tightening of monetary policy and thus reduce the risks of snuffing out the country's nascent economic recovery, economists said.
As the most liquid currency in emerging Europe, the zloty -- in a free float since 2000 -- is most vulnerable to moves by the euro, the region's main reference unit.
Some central bank and government officials say the zloty's fair level lies in a range of 3.9-4.0 to the euro and any external factors pushing the euro down against the dollar pose a potential threat to the zloty's 'fair levels', dealers say.
BGK's zloty purchases, branded "soft intervention" by traders, coincides with fresh selling pressure on the Polish unit because of the ructions in the euro zone linked to Ireland's debt crisis. The currency fell below the 4.04 level per euro on Friday.
VERBAL INTERVENTIONS
Then, Prime Minister Donald Tusk's verbal intervention helped to pull the zloty back. This week, in similar vein, comments by central bank governor Marek Belka saying the zloty had "great potential" to appreciate by more than 10 percent provided support, though he gave no timeframe.
Dealers last said the government was selling EU funds through BGK to defend the zloty in May 2010, an operation that managed to halt a 2 percent slide in the zloty and sparked a slight rebound.
In 2011, the Polish authorities want the zloty to remain steady but not to appreciate too fast for fear of derailing an economic recovery already potentially put at risk by the euro zone crisis, economists said.
The latest Reuters poll sees the zloty at around 3.80 to the euro over the next 12 months, a view endorsed by Ernest Pytlarczyk, chief economist at BRE bank in Warsaw.
"I think the zloty will appreciate, but in a very gentle, almost 'flat' trend," he said. "Inflation is likely to rise next year, so they can't afford the zloty to be too weak."
Inflation stood at 2.8 percent in October, above the central bank's 2.5 percent target, and is seen accelerating in coming months as Poland's economic recovery gathers pace. (Editing by Gareth Jones and Toby Chopra)