(Adds comments from Moody's analyst)
By Bruno Federowski and Brad Haynes
SAO PAULO, Dec 9 (Reuters) - Moody's Investors Service put Brazil's credit rating on review on Wednesday for a possible downgrade to junk status due to a severe economic recession, failed austerity efforts and rising risks of political paralysis.
Moody's said it based its decision on "worsening governability conditions" after Congress opened impeachment proceedings against President Dilma Rousseff.
If Moody's follows through with a downgrade in the usual three-month review period, it would be the second ratings agency to strip Brazil of its investment-grade status, following a cut by Standard & Poor's in September.
A second downgrade to junk is likely to trigger capital outflows because many foreign pension funds and other large investors are required to unload bonds once two separate agencies rate them as speculative grade.
A Moody's downgrade could drive some $1.6 billion of investments out of the Brazilian market, estimated Barclays economist Bruno Rovai.
The Brazilian real plunged to a record low in September after the S&P downgrade to junk, but the currency rebounded more recently as fears of sudden capital flight eased.
Local market reaction to Moody's move on Wednesday was largely imperceptible.
"The impact is negative because of the obligatory adjustment among funds, but ... a good part of that foreign adjustment has been made by markets," said Juliano Ferreira, a strategist with the Icap brokerage in Sao Paulo.
"The volume of dollars that could leave the country due to a downgrade isn't what it would have been in the past," he added.
Moody's said it had taken the decision due to "rapidly and materially deteriorating macroeconomic and fiscal trends and diminished likelihood of trend reversal in the next 2-3 years."
Moody's senior analyst Samar Maziad told Reuters later that Brazil's fiscal and economic outlook was no longer likely to improve starting in 2017 as previously expected because impeachment proceedings have drawn Congress' attention away from passing measures needed to improve the country's accounts.
"It makes a complicated political dynamic even more complicated," she said.
"The longer it takes, the worse (it is)," added the analyst, referring to the impeachment proceedings.
Economic data last week showed Brazil's economy contracted 4.5 percent in the third quarter from a year earlier, confirming the worst recession in 25 years as investment plunged and inflation jumped above 10 percent per year. (Additional reporting by Flavia Bohone and Marcelo Teixeira; Editing by Sandra Maler)