* Finance Minister wants to shift some pension assets to state vehicle
* He rules out scrapping private element of pension system
* Markets relieved that there are "no radical steps"
* Lobby group says proposals will destroy private funds
By Pawel Sobczak and Dagmara Leszkowicz
WARSAW, June 26 (Reuters) - Poland's finance minister proposed shrinking the role of private funds in the state pension system on Wednesday but ruled out a more drastic option, which had rattled markets, of pushing the funds out of the system altogether.
The minister, Jacek Rostowski, recommended moving some of the assets from private pension funds into a state vehicle, a reform that will bring down public debt and give him leeway to spend more to soften the impact of a sharp economic slump.
The proposed reform was a balancing act designed not to alarm markets. They fear that if the private funds are shrunk too severely, they will invest less actively in the Polish bond and equities markets where they are major players.
The main share index, WIG20, fell to a one-year low in early trading in anticipation of the proposed reforms. It later regained some of the lost ground when markets realised the proposals were more nuanced than they expected.
Rostowski said he was recommending that, starting from the point when people are 10 years from retirement age, the part of their pension pot which is in private funds should be gradually transferred to the state pension vehicle.
Unveiling a long-awaited review, he said though that the option of completely liquidating the private element of the state pension system was not being recommended.
"There are no radical steps, and this is good news," said Grzegorz Maliszewski, chief economist at Millennium Bank
But the private pension funds themselves said the proposed reforms would mean a slow death. Firms involved in the Polish state pension system include ING, Aviva Allianz , and Axa
Malgorzata Rusewicz, head of industry lobby group IGTE told Reuters that if the recommendations are enacted, the private funds as a part of the state pension system "will slowly be extinguished."
The private funds holds assets worth a total of 280 billion zlotys ($84.45 billion), equivalent to about one fifth of Poland's economic output.
In reforming pensions, the government has to reconcile a conflict. On the one hand is its desire to preserve its reputation as a model of pro-market policies, and on the other, the urgent need to find cash to help the spluttering economy.
The government cannot spend more because of strict ceilings on public debt. Transferring assets from the private funds to a state pension vehicle will push down that debt, giving the government room for maneuver.
Poland has a hybrid pension system. Workers and the state are required to pay contributions into both the state vehicle, known as ZUS, and into the private funds.
Rostowski said that, in addition to the phased transfer of assets for the last 10 years of citizens' working life, he was proposing a menu of options from which Poland could choose.
Those options included making participation in the private funds voluntary, and shifting government bonds held by the private funds into the state vehicle.
"I do not have a preferred option. If I had, we would have presented it," Rostowski told a news conference.
The transfer of assets from the private funds to the state vehicle is likely to have an impact on bond and equity markets.
Rostowski said Polish government bonds the state acquires from the private funds would be written off. He said shares might be given to private funds to manage.
The proposals will now be the subject of a month-long public consultation, after which the government will decide what reforms to submit to parliament for approval.
The government denies the reform is about the cash-strapped state looking for sources of cash. It says the pension system as it stands now is not giving pensioners a square deal and is not promoting growth as much as it could.