The current financial market disruptions will most likely be followed by global economic stagnation in 2009 and 2010, says Moody’s Investors Service in a new report.

Even as the financial crisis in its most severe form subsides, Moody’s expects to see less capital being risked across the globe and lower growth.

In a report released Friday, Moody’s says its central scenario — “Global Healing” — calls for a very sharp downturn in the advanced economies, with some contraction in 2009 followed by below-potential growth in 2010. Moody’s expects the emerging market economies to post growth short of their potential during the two-year period.

This scenario of painful economic convalescence describes a U-shaped recovery for advanced economies, but output losses are unlikely to be recovered rapidly and elevated risk aversion will persist in credit markets for a prolonged period.

In the report, Moody’s also poses two less likely alternative risk scenarios for 2009-2010.

A more positive scenario (“Global Resiliency”) is one where the process of international economic and financial integration is just temporarily slowed. The scenario posits the U.S. economy enduring only a very mild and short-lived contraction because of massive fiscal and monetary policy stimulation, with the rest of world experiencing a sharp deceleration in the last quarter of 2008 and first quarter of 2009, when growth would resume. This scenario of V-shaped economic recovery sees also a resumption of capital flows and liquidity below but not far away from pre-crisis levels.

The least likely of the three Moody’s scenario is that a sharp contraction in credit gathers pace, leading to a collapse of global trade, commodity prices, and financial flows. If this were to happen, growth would remain negative in the United States and Europe throughout the 2009 and 2010 period. Such negative scenario — better described as L-shaped — is closer to the Japanese “lost decade” of the 1990’s than to the 1930’s episode. In such scenario, despite intense policy activism, credit remains quantity constrained, leading to widespread economic and financial dislocations.

“The central question that will determine the final outcome as we look beyond the current disruption is whether policy action can engineer a mild and short contraction,” says Pierre Cailleteau, Moody’s chief international economist and author of the report. “Specifically, can they contain the recessionary pressure associated with a much lower equilibrium for the demand and supply of credit?” He adds “one foregone conclusion is that, in all scenarios, risk socialization fuels a massive expansion of government balance sheets and, in particular, poses serious future challenges in terms of deleveraging governments.”

Cailleteau adds, “Before, Moody’s risk scenarios reflected states of the world where economic and financial imbalances either translated into stagnation, stagflation or decoupling. Now their common concern is the question of global growth and the future of international economic and financial integration.”

IE