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UPDATE 1-Brazil auto industry stagnates as gov't pares stimulus

(Adds industry background, policy context, sales by brand)

SAO PAULO, June 5 (Reuters) - Brazil's auto industry remained stagnant in May, with production and sales well below levels in the same month a year earlier, as weak demand, high inventories and fading government stimulus took a toll.

Automobile production edged up 1.9 percent and sales were flat in May from April, the national automakers' association said on Thursday. Compared to May 2013, auto output slid 18.0 percent and sales dropped 7.2 percent.

Global carmakers, whose local factories account for a fifth of Brazil's industrial output, have been furloughing workers and offering buyouts as they struggle with excess capacity and plunging consumer confidence. Employment in the industry is down 2.8 percent from a year earlier.

Although President Dilma Rousseff has worked to keep unemployment down ahead of her reelection campaign this year, the government has little room to continue offering the fiscal stimulus that saved the industry from past crises.

Auto production through May of this year has fallen 13.3 percent compared to the first five months of 2013, and accumulated sales so far this year are down 7.2 percent.

Government officials have dropped planned measures to boost auto loans, a source told Reuters on Wednesday. Finance Minister Guido Mantega said carmakers cannot count on more government help.

"The industry has to walk on its own legs," Mantega told journalists on Wednesday, adding that Brazil will continue restoring an industrial tax it first cut early in 2012 to jumpstart the economy.

Despite waves of costly stimulus, Brazil's economy has grown just 2 percent on average since Rousseff took office in 2011. Protectionist industrial policies have forced carmakers to invest more in local factories and excess capacity has begun to hurt profitability.

Brazil is the world's fourth-largest auto market and a key base of operations for automakers including Italy's Fiat SpA , Germany's Volkswagen AG and U.S.-based General Motors Co and Ford Motor Co.

Automakers in Brazil produced 282,500 new cars and trucks last month, while sales totaled 293,400 vehicles, according to data released by industry group Anfavea.

Fiat remained Brazil's top seller of cars and light trucks in May, with about 55,900 new registrations. VW took second place from GM, selling some 50,100 passenger vehicles compared to about 48,900 cars and light trucks sold by its U.S. rival. Ford sold nearly 24,400 vehicles.

(Reporting by Alberto Alerigi Jr.; Writing by Brad Haynes; Editing by Chizu Nomiyama and G Crosse)