* Brazil to peg savings to Selic rate, Mantega says
* Savings rules reform is key to lower interest rates
* Uproar from Brazilians and banks is possible
* Doubts remain over risk of inflation, defaults (Updates with Mantega, analyst comments)
By Jeferson Ribeiro and Tiago Pariz
BRASILIA, May 3 (Reuters) - President Dilma Rousseff took a bold but risky step to shake Brazil from its recent economic funk on Thursday, overhauling 19th century-era rules governing domestic savings accounts to allow interest rates to fall further in coming months.
Rousseff has made cutting Brazil's interest rates a top priority as she tries to revive an economy that has been on the brink of recession since mid-2011. The benchmark Selic rate is at 9 percent, near historic lows for Brazil but exorbitant compared to rates close to zero in Europe and the United States.
One of the main obstacles to bringing the Selic down further has been the fixed rate of return for savings accounts, Brazil's most popular investment vehicle. The rate is currently set at about 6 percent annually, which, once tax incentives and other factors are taken into account, amounts to a de facto floor for the Selic at or around its current level.
Finance Minister Guido Mantega told reporters the government will scrap the fixed rate when the Selic is at or below 8.5 percent. In such cases, the return on savings accounts would be set at a level equivalent to 70 percent of the Selic, he said.
The current system of fixed returns would remain in place when the Selic is above 8.5 percent, Mantega said. The changes, which take effect via presidential decree on Friday, will apply to new savings accounts and new deposits in existing accounts.
"In order to reduce financial costs and reduce interest rates on credit, which are still very high, we have to free up our system by making this modification to savings accounts," Mantega said.
The proposal carries enormous political and economic risks and amounts to a reengineering of one of the basic pillars of Brazil's financial system. The accounts' perceived safety and fixed returns, which date back to at least 1861 when Brazil was still an empire, are highly valued by savers because of their country's long history of financial turmoil.
Some analysts say Rousseff's push for easier monetary conditions is premature and warn that persistent inflationary pressures could blow up in the form of higher default rates in coming months.
Brazil's central bank has de facto autonomy to set the Selic, although Rousseff has proclaimed her desire for lower rates in several speeches this week, and investors say the popular, left-leaning leader is likely to get what she wants.
Andre Guilherme Pereira, an economist for Gradual Investimentos, called the savings plan a "historic decision."
"We wish all the luck in the world to the government," he wrote in a note to clients early on Thursday. "They're making a really, really high-stakes bet."
Brazil's currency and interest rate futures markets have been highly volatile this week as investors try to account for the changes to savings accounts.
By setting 8.5 percent as the threshold for the changes, the initiative signals that Rousseff is paving the way for the Selic to fall further than some analysts had anticipated from its current 9 percent. Some investors had been betting on only another cut of a quarter-percentage point.
Still, some doubts about Rousseff's strategy remained.
Alberto Ramos, a senior economist at Goldman Sachs in New York, said the move to change savings account rules was "positive" because it eliminated a structural barrier to improving Brazil's financial system. But he said it might be happening "for the wrong reasons."
"I don't think they should lower rates more," Ramos said. "Deliver inflation like a developed economy, and then you might have the rates of a developed economy."
Inflation in Brazil was 5.25 percent in the 12 months through mid-April, and closed 2011 at a 7-year high.
The central bank cut the Selic 75 basis points last month, and it is now down 350 basis points since August. In minutes from its latest monetary policy meeting, the bank left the door open to further rate cuts in coming months.
Brazilians hold more than 431 billion reais ($225 billion) in savings accounts, Mantega said. The accounts are especially cherished by members of Brazil's emerging lower-middle class, who remain wary of higher-yield investments like bonds.
Many Brazilians are still traumatized by former President Fernando Collor's attempt to freeze savings accounts in the early 1990s. An attempt by Rousseff's predecessor to modify the rules in 2009 was abandoned because of a public outcry.
By passing the measure via decree, Rousseff ensures it will go into effect right away. However, Brazil's Congress must approve the measure within 120 days, and approval is not certain with municipal elections looming in October.
Even before the details became public, the opposition PSDB party's leader in the Senate decried the changes.
"The first victim of this effort against high interest rates is the small saver," Senator Alvaro Dias said.
"The decree is going to cause a good debate," Arlindo Chinaglia, the ruling coalition's leader in the lower house, told Reuters. "It shows the president is going to govern the country with the present day and coming decades in mind."
Despite the threat of a backlash, Rousseff appears prepared to stake her reputation and high public approval ratings on the issue, believing that lower rates are a necessary condition for Brazil to resume the high economic growth rates that made it a star among emerging markets during the past decade.
Brazil's economy grew just 2.7 percent in 2011 after a blazing 7.5 percent expansion in 2010. The main drag on the economy has been sagging manufacturing - which would also benefit from lower interest rates, as the currency weakens and makes Brazilian products more competitive with imports. ($1 = 1.92 Brazilian reais) (Additional reporting by Maria Carolina Marcello in Brasilia and Patricia Duarte in Sao Paulo; Writing by Brian Winter; Editing by Todd Benson)