The country music legend has known the 'Hannah Montana' star - whose father is country singer Billy Ray Cyrus - since she was a baby and admits she feels protective of her.
She said: "She's my honorary goddaughter. I mean, we never had a ceremony or nothing.
"I've known her since she was a baby. I hate it when people criticise her."
The 64-year-old star praised the singer-and-actress' performing talents but also admitted the teenager is good company out of the spotlight.
She added in an interview with Fox News: "She is a great singer, she has a great voice. She's a great little entertainer and she can speak to you like she is 50 years old."
Despite the criticism Miley has received for her risque outfits and raunchy dancing, Dolly insists the 17-year-old star is just a normal girl trying to grow up in her own way.
She said: "She'll land in the right place. I really know she has everything it takes. She is just trying to find her way and she will."
Miley has previously spoken of her admiration for Dolly.
She said: "She is the nicest person in the world. She's so easy to talk to. She's awesome. I love her.
"She always tells me just to do what I love and if I'm not having fun it's not working. I don't know how old she is at this point but every time she is on the stage she is smiling from ear to ear."
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