* IOF tax extended to foreign debt issues up to 5 years * Gov't battling dollar inflows to tame currency strength * Real weakens near 2 pct to two-month low on new measure * Economists still doubt long-term effectiveness of move By Brad Haynes SAO PAULO, March 12 (Reuters) - Brazil extended the reach of a financial tax on foreign debt on Monday in another attempt to slow dollar inflows that have driven up its currency and threatened a fragile economic recovery. President Dilma Rousseff extended the scope of a 6 percent tax known as the IOF on foreign borrowing, applying it to debt maturing in up to five years, according to a decree in the government's official daily gazette. The tax had previously been charged when companies in Brazil took foreign loans and issued bonds abroad with a maturity under two years. It was extended to three years on March 1. Rousseff has blamed loose monetary policy in developed economies for foreign cash flows into Brazil's financial markets fueling the appreciation of the local currency, the real. The stronger currency has unleashed a flood of cheap imports and hurt the competitiveness of struggling Brazilian industries. The tax increase is a preventive measure aimed at slowing the tide of "speculative capital" flowing into Brazil, the Finance Ministry said in a statement. The real weakened 1.8 percent on Monday to 1.817 per dollar, its weakest level in two months. The tax measures and more aggressive market interventions by the central bank have weakened the real by more than 5 percent so far this month, making it one of the world's worst performing currencies. Still, economists questioned the long-term effectiveness of the measure, noting that it would only affect a small portion of Brazilian corporate debt. "Ultimately, they didn't have any impact on the real the last time around in 2010 and the first half of 2011," said Neil Shearing, senior economist with Capital Economics in London, citing a rally that pushed the real to 1.55 per dollar. "I suspect they're only really swimming against the tide this time around too," he added. Goldman Sachs Group economist Alberto Ramos told clients in a note that the IOF measures would have a limited impact on the exchange rate given the average maturity of Brazilian companies' foreign bond issues is around 10 years. Most Brazilian companies are taking advantage of inviting market conditions this year to issue debt of 10 to 15 years, according to Italo Lombardi, Latin America economist with Standard Chartered in New York. ALLURING INTEREST RATES Brazil is struggling to reduce the allure of its interest rates, the highest among major economies, to foreign investors seeking bigger returns than those available in larger developed economies. Brazil's central bank slashed its Selic overnight rate by a larger-than-expected 75 basis points last week to 9.75 percent. Economists see more aggressive rate cuts on the way. That would be welcome news for Rousseff who has made lowering interest rates a main focus of her government. "The rate cuts by the central bank aren't just meant to heat up the Brazilian economy. I applaud the bank because the larger intent is to balance domestic and international rates," said Rousseff in an interview with a local news Web site on Sunday. But relatively loose fiscal policy and a tight job market are expected to fuel nagging inflationary pressures by the end of the year, forcing interest rates higher again in 2013, according to analysts in a weekly central bank survey published on Monday. Easing fears about the European debt crisis have boosted investors risk appetite since the start of the year, sending cash into higher-yielding assets like Brazilian debt and fueling the real's nearly 9 percent rally in January and February. The currency surged as Brazil's industry struggled through its rockiest stretch in years, contracting three times more than economists expected during January and piling pressure on officials to act. Stagnating industry slowed economic growth to 2.7 percent last year, adding to concerns Brazil had become complacent after the economy expanded 7.5 percent in 2010. Critics say the government lacks the political will to address the taxes and crumbling infrastructure that are choking growth. Brazilian authorities have denounced what they call a "currency war" prompted by monetary stimulus and subsidized lending in major world economies. Finance Minister Guido Mantega on Friday said the government will take further measures to ensure the currency is not overvalued. "What's scary is how all of this could impact overall appetite for investment in Brazil," said Lombardi, of Standard Chartered. "Although they (Brazilian government) have reaffirmed they are not going to tax foreign direct investment... you never know, they are being very aggressive." Mantega has distinguished between restrictions on shorter-term cash flows into domestic capital markets and the foreign direct investment (FDI) crucial to sustained economic growth. Some analysts have questioned how much of Brazil's FDI flows are in fact a disguised play on fixed income assets, a claim Mantega said he found unlikely but would investigate.