BRASILIA (REUTERS) - Brazilian President Dilma Rousseff's efforts to bolster her government amid a storm of corruption allegations by naming her predecessor Luiz Inacio Lula da Silva to her Cabinet were overshadowed on Tuesday by a barrage of fresh accusations against a minister.

Presidential aides said the charismatic Lula, Brazil's first working class president, had decided to accept a ministerial position in Rousseff's Cabinet, a move that would offer him protection in the short-term from prosecutors who have charged him with money laundering and fraud.

One of the aides, who asked not to be identified so he could speak freely, said Lula, a talented negotiator, would take charge of legislative affairs, where he could leverage his close ties to congressmen from the ruling Workers Party to rally votes for the government.

The return to public office of Lula, who stepped down in 2010 after eight years in power as one of the world's most popular leaders, was slammed by critics as a desperate attempt to shore up support for Rousseff as she faces impeachment proceedings in Congress.

Rousseff's popularity has been pummelled by Brazil's worst economic downturn since the Great Depression and the spreading corruption investigation focused on state-run oil company Petrobras.

More than a million people marched in demonstrations across Brazil on Sunday, calling for her ouster and voicing support for the investigations into kickbacks by contractors to political leaders in exchange for work with Petrobras.

Plans to announce Lula's appointment were overtaken by the publication of damaging new allegations from a Workers' Party senator in plea bargain testimony made public by the Supreme Court on Tuesday.

The testimony by Senator Delcídio do Amaral, a close ally of the president until he was arrested last year, accused both Rousseff and Lula of being aware of corruption at Petroleo Brasileiro SA and said the president had tried to hamper the investigation.

In the most damaging allegations, Amaral said Aloísio Mercadante, a Workers' Party veteran who has served as Rousseff's chief-of-staff and is now education minister, offered to pay him to keep quiet last year.

Mercadante called a news conference to deny the accusation, that was based on a recording of two meetings between the minister and Amaral's personal secretary.

Presidential aides said the accusations had overshadowed any announcement of Lula joining the Cabinet.

"We were hoping to change the mood with Lula's appointment, but this recording is another huge blow," one aide told Reuters.

INVESTORS TAKE FRIGHT

Investors, who have long blamed Rousseff for erratic policies they believe hurt the economy, had bought up Brazilian assets in recent days because of the increasing likelihood that the president might be ousted.

However, they fretted on Tuesday that Lula's return to government could lead to increased spending in the short-term in the midst of a fiscal crisis. Lula and many Workers' Party allies have said more spending is necessary to revert dwindling support for the government.

Brazil's benchmark Bovespa stock index fell 3.5 per cent and the Brazilian currency weakened 3 per cent against the US dollar on the news.

Lula, who became a hero to many for lifting millions out of poverty during his 2003-2010 government, is under investigation on suspicion he benefited from the massive graft scandal that has ensnared dozens of corporate leaders and politicians in Rousseff's governing coalition.

Accepting a Cabinet post would transfer potential money laundering charges against him from Federal Judge Sergio Moro to Brazil's Supreme Court.

Brazil's Attorney General Jose Eduardo Cardozo denied the government was trying to shield Lula from prosecution and said there were no legal or political impediments for him to join the Cabinet. "Lula is not fleeing from justice. There is no attempt of any sort to shield him," Cardozo told reporters.

Rousseff's main coalition partner, the PMDB party, whose leaders in Congress are also being investigated for corruption, has been moving toward breaking with her government and supporting her impeachment. That would put its leader, Vice President Michel Temer, in the presidential seat.

"The appointment of Lula as minister shows Brazilians that the government's only concern today is to survive at any cost,"opposition leader Aecio Neves, who narrowly lost to Rousseff in 2014, said in a Twitter message.

Amaral's plea-bargain extended the reach of the corruption probe to new industries, including ethanol, and to opposition leaders, including Neves, who the senator accused of received kickbacks from a unit of Eletrobras, Brazil's state-led electricity utility.