* Brazil to announce rules in coming weeks -gov't sources * Carmakers need more fuel efficiency to keep tax discount * New standards should boost investment in engine plants By Jeferson Ribeiro BRASILIA, Sept 10 (Reuters) - Brazil will demand that carmakers improve fuel efficiency by 11 percent next year or lose a substantial discount on their tax bill, according to two government sources, in a move expected to bolster a wave of investments in local engine plants. The government has been putting finishing touches on fuel efficiency regulations under a new law that gives a hefty tax advantage to cars made with a minimum amount of local and regional content in the world's No. 4 auto market. Carmakers who do not meet the local content requirements would see their tax bills rise 30 percentage points. Taken together the regulations are raising pressure on carmakers to boost local investments if they want to tap Brazil's vaunted demand -- the most protectionist shift in the market since it opened to auto imports two decades ago. "What we're doing is bringing the Brazilian auto industry in line with the rest of the world. That will give a new boost to vehicles exported from Brazil," said one government source, adding that the new rules should be out within weeks. Rising costs and rigid labor laws have eroded the competitiveness of Brazilian auto exports, which slumped 30 percent last year from five years before. The source added that companies could further reduce a key industrial tax by two percentage points if they can improve fuel efficiency by a full 22 percent. A representative of the auto industry confirmed that negotiations were "headed in that direction, although there are several points to work out." The new standards are likely to expand a wave of investments in local engine production of the sort recently announced by Renault and Toyota Motor Corp, said Milad Kalume Neto, the head of consultancy Jato Dynamics in Brazil. "I think there's going to be a movement changing over to new materials and technologies, like the 'engine downsizing' that Europe went through," said Neto, calling the motors used in Brazil "extremely outdated." Government policy has also stimulated the use of 'flex-fuel' engines in Brazilian vehicles, which can burn gasoline, sugarcane-based ethanol or both mixed, but with slightly less efficiency than an engine tuned for either fuel alone. Most auto production in Brazil comes from Italy's Fiat SpA , Germany's Volkswagen AG and U.S.-based General Motors and Ford Motor Co.