* Congress puts key legislation on ice
* Leaders furious with Rousseff over budget cuts
* World Cup law, forestry code among bills on hold
By Ana Flor
BRASILIA, March 19 President Dilma Rousseff will try to quell a rebellion among Brazilian legislators by releasing some frozen funds for their pet projects, sources told Reuters, hoping that will convince them to pass critical legislation for the 2014 World Cup and other bills related to the economy.
Rousseff has struggled since taking office last year with unrest among the 17 parties that make up her coalition in Congress. The latest conflict followed Rousseff's decision to freeze about $30 billion in funds in this year's budget, a move which she hoped would contain inflation while allowing Brazil's high interest rates to keep falling in coming months.
Rousseff focused most of the cuts on Congress' so-called "discretionary" funds, which legislators use for projects back home. Legislators have retaliated by holding up most of Rousseff's agenda and threatening to pass bills that could sabotage Brazil's already-fragile economy.
After tensions soared in the past two weeks, Rousseff aides have informed legislators that she will be releasing a tranche of the money in early April, earlier than previously planned, the sources told Reuters. The sources spoke on condition of anonymity because they were not authorized to speak publicly.
The sources did not say how much money would be released, so it was not possible to gauge the possible effect on Brazil's fiscal accounts. The total spending freeze announced in February was equivalent to about 2.5 percent of the overall budget.
Still, the fact that Rousseff would yield to pressure just a month after announcing the freeze is a worrying sign for Brazil's finances going forward, said Flavia Cattan-Naslausky, an analyst for RBS Securities.
"Brazil has made efforts on the fiscal front, but ... the problem with Brazil is that it's never as tight an effort as it should be," Naslausky said. "This news will add to the feeling among investors that the policy mix isn't that strong."
"WE'LL HAVE TO HIRE PSYCHIATRISTS"
The confrontation has highlighted how political deadlock is dragging down Brazil's economy, which expanded only 2.7 percent last year, compared to 7.5 percent in 2010. Many investors blame part of the slowdown on Rousseff's inability to push through major reforms to taxes or other areas that would make Latin America's biggest economy more competitive abroad.
Congress has also refused to pass legislation outlining regulations for the World Cup, which Brazil will host in 2014. World soccer body FIFA has grown frustrated with the delay, with one senior official saying that Brazilian officials needed a "kick up the backside" to be ready on time.
Rousseff was embarrassed last week when a vote on the World Cup law, which covers such things as ticket prices and the whether alcohol can be sold in stadiums, was delayed once again.
"It was a mess," Vicente Candido, a legislator from her party and the bill's sponsor, told reporters. "We'll have to hire psychiatrists to find out what happened."
Rousseff met on Friday with FIFA chief Sepp Blatter. A government source told Reuters that Rousseff assured him the Cup legislation would be passed as early as this week.
Rousseff also replaced her designated interlocutors with Congress last week in an attempt to move on from the recent tensions.
Still, her problems are far from over. Newspaper Folha de S.Paulo reported on Sunday that lower-house deputies from two medium-sized parties were debating leaving Rousseff's coalition. Their members account for 38 of the 513 representatives in the lower house.
Other legislation could remain on hold for the foreseeable future. The head of the lower house, Marco Maia, has admitted that a controversial new forestry code might have to wait a few weeks for tensions to ease before it can be put to a vote.
Farmers are anxious for the law to be passed to end years of legal insecurity over shifting land-use rules. It will reduce the amount of forest coverage many of them are forced to replace on their plantations but the collective bill for the areas they will still need to reforest will run into billions of dollars.
A presidential source said the forestry legislation could be put on ice if necessary until after Rio+20, a United Nations environmental conference Brazil is hosting in June, to avoid the risk of a defeat in Congress.