<PAGE>
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<TABLE>
<S> <C>
DIRECTORS OFFICERS
Barton M. Biggs James W. Grisham
CHAIRMAN OF THE BOARD VICE PRESIDENT
Chairman and Director, Morgan Stanley Michael F. Klein
Asset Management Inc. and Morgan Stanley VICE PRESIDENT
Asset Management Limited; Managing Harold J. Schaaff,
Director, Morgan Stanley & Co. Jr.
Incorporated; Director, Morgan Stanley VICE PRESIDENT
Group Inc. Joseph P. Stadler
Warren J. Olsen VICE PRESIDENT
DIRECTOR AND PRESIDENT Valerie Y. Lewis
Principal, Morgan Stanley Asset SECRETARY
Management Inc. and Morgan Stanley & Co. Karl O. Hartmann
Incorporated ASSISTANT SECRETARY
John D. Barrett II James R. Rooney
Chairman and Director, TREASURER
Barrett Associates, Inc. Joanna M. Haigney
Gerard E. Jones ASSISTANT TREASURER
Partner, Richards & O'Neil LLP
Andrew McNally IV
Chairman and Chief Executive Officer,
Rand McNally
Samuel T. Reeves
Chairman of the Board and CEO,
Pinacle L.L.C.
Fergus Reid
Chairman and Chief Executive Officer,
LumeLite Corporation
Frederick O. Robertshaw
Of Counsel, Bryan, Cave LLP
</TABLE>
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INVESTMENT ADVISER AND ADMINISTRATOR
Morgan Stanley Asset Management Inc.
1221 Avenue of the Americas
New York, New York 10020
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DISTRIBUTOR
Morgan Stanley & Co. Incorporated
1251 Avenue of the Americas
New York, New York 10020
- ---------------------------------------------------------
CUSTODIANS
The Chase Manhattan Bank
770 Broadway
New York, New York 10003
Morgan Stanley Trust Company
One Pierrepont Plaza
Brooklyn, New York 11210
- ---------------------------------------------------------
LEGAL COUNSEL
Morgan, Lewis & Bockius LLP
2000 One Logan Square
Philadelphia, Pennsylvania 19103
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INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
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For current performance, current net asset value, or for assistance with your
account, please contact the Fund at (800) 548-7786. This report is authorized
for distribution only when preceded or accompanied by prospectuses of the Morgan
Stanley Institutional Fund, Inc.
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
P.O. Box 2798
Boston, MA 02208-2798
[LOGO] MORGAN STANLEY
INSTITUTIONAL FUND, INC.
EMERGING MARKETS DEBT PORTFOLIO
FIRST QUARTER REPORT
MARCH 31, 1997
<PAGE>
LETTER TO SHAREHOLDERS
- -------
The investment objective of the Emerging Markets Debt Portfolio is high total
return through investment primarily in debt securities of government,
government-related and corporate issuers located in emerging countries.
For the three months ended March 31, 1997, the Portfolio had a total return of
4.51% for the Class A shares and 4.52% for the Class B shares as compared to a
total return of 0.79% for the J.P. Morgan Emerging Markets Bond Plus Index. The
average annual total return for the one year ended March 31, 1997 and for the
period from inception on February 1, 1994 through March 31, 1997 was 49.81% and
18.99%, respectively, for the Class A shares as compared to 35.03% and 12.34%,
respectively, for the Index. As of March 31, 1997, the Portfolio had a 30-day
yield of 8.78% for the Class A shares and 8.50% for the Class B shares.
PERFORMANCE COMPARED TO THE J.P. MORGAN EMERGING MARKETS BOND PLUS INDEX(1)
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<TABLE>
<CAPTION>
TOTAL RETURNS(2)
-----------------------------------------
ONE AVERAGE ANNUAL
YTD YEAR SINCE INCEPTION
--------- ----------- -----------------
<S> <C> <C> <C>
PORTFOLIO - CLASS A......... 4.51% 49.81% 18.99%
PORTFOLIO - CLASS B(3)...... 4.52 49.37 42.40
INDEX....................... 0.79 35.03 12.34
</TABLE>
1. The J.P. Morgan Emerging Markets Bond Plus Index is a market weighted index
composed of Brady bonds, loans and Eurobonds, as well as U.S. Dollar local
market instruments of Argentina, Brazil, Bulgaria, Mexico, Morocco, Nigeria,
the Philippines, Poland, Russia and South Africa.
2. Total returns for the Portfolio reflect expenses waived and reimbursed, if
applicable by the Adviser. Without such waiver and reimbursement, total
returns would be lower.
3. The Portfolio began offering Class B shares on January 2, 1996.
PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
- ------------------------------
THE PERFORMANCE RESULTS PROVIDED ARE FOR INFORMATIONAL PURPOSES ONLY AND SHOULD
NOT BE CONSTRUED AS A GUARANTEE OF THE PORTFOLIO'S FUTURE PERFORMANCE. PAST
PERFORMANCE SHOWN IS NOT PREDICTIVE OF FUTURE PERFORMANCE. INVESTMENT RETURN AND
PRINCIPAL VALUE WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES, WHEN REDEEMED, MAY
BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. PLEASE SEE THE PROSPECTUS FOR A
DESCRIPTION OF CERTAIN RISK CONSIDERATIONS ASSOCIATED WITH INTERNATIONAL
INVESTING. YIELDS WILL FLUCTUATE AS MARKET CONDITIONS CHANGE.
For the first few weeks of the year the trend of an across the board tightening
of credit spreads continued unabated. Attractive relative valuations, the
stretch for incremental yield, improving sovereign credits and easy global
monetary conditions prompted continued increases in allocations to emerging
market assets. Chairman Greenspan's comments on the state of credit markets,
extended valuations and mispricing of risks stopped the music suddenly. A
correction in fixed income markets started in the last week of February and
lasted for practically all of the month of March.
It is always easier with hindsight to point out the excesses in financial
markets, but the only common theme this time around was the fact that it was no
different than the last time we encountered clear-air turbulence in emerging
markets. Valuations always look stretched but somehow always justifiable,
late-comers to the party are the first to get "excessively exuberant",
self-fulfilling circular loops of logic are in fashion, hot investment ideas
proliferate as bull market geniuses are spawned every day and unsuspecting
investment professionals dance to the "its different this time around" chorus.
Before anyone knows it, a bear market/serious correction suddenly appears from
out of the blue. The specific catalyst or trigger can somehow never be
anticipated, as corrections seldom arrive accompanied by the sound of drums and
music. Two things remain true no matter what: that bulls are mortal and it
always appears pitch black before the dawn of a rally. So when the Fed is
expected to move another 100 basis points in 1997, political cycles are expected
to wreck the improving economic stories, oil prices are headed to $10 a barrel
and some emerging country is close to a default, it will be time to buy emerging
market bonds again. Or will it?
The markets didn't surprise by behaving differently this time around. An
increase in risk premiums affected all countries and all bonds. A correction,
precipitated by possible Fed action and deepened by redemptions and a reduction
in committed capital, tends to affect the broad market. Hot investments tend to
get hit the hardest as positions need to be reduced and the demand supply
2
<PAGE>
imbalance grows exponentially. The weight of money heading for the exits drowns
the fundamentals for a while. The overbought and the overowned assets
underperformed as expected. The only safe havens proved to be short-duration
floating rate bonds of Argentina, Brazil and Morocco. The resilience of the
Mexican peso surprised everyone and assets with low correlations with the broad
market performed reasonably.
Over the course of the quarter though, the improving credit stories did
outperform. Argentina, Brazil, Bulgaria, Mexico and Morocco did manage to hold
on to positive returns. The countries with deteriorating outlooks
underperformed. Ecuador, Venezuela and Russia took up the rear of the
performance pack. The performance of Panama, Peru, Philippines and Poland proved
to be nothing to write home about.
The Portfolio outperformed by sticking to our convictions. Buying cheap credits
with an improving economic outlook proved successful in Bulgaria as we retained
our overweight in the best performing country for the quarter based on the
premise that a political consensus existed to undertake serious macroeconomic
stabilization for the first time in many years. A transition government that
replaced the ex-socialists negotiated for help from the International Monetary
Fund, the World Bank and the European Union for external financing that would
improve the country's ability to implement a currency board after the elections
scheduled for mid-April. The reformers are expected to win and implement the IMF
prescribed stabilization and de-regulation program.
Our focus on values and improvement steered us away from the pitfalls in Ecuador
as an ambitious President was ousted by the population on charges of corruption,
nepotism and conservatism. Economic policies, however well crafted, need careful
execution. Ecuador reminded us that drastic reform can run the risk of a
backlash. We managed to side-step the problems by reducing our exposure as
valuations became stretched and the first sign of trouble emerged.
Mexico proved to be a difficult country in 1997. The strong tail-winds of firm
oil prices, low global interest rates and a weak peso turned into head winds for
the first time since the crisis of 1995. Expensive assets and risk of further
political upheaval before the elections in July did not warrant an excessive
allocation. The country performed well in January as excessive liquidity drove
spreads lower but has underperformed the market since.
Argentina, on the other hand, was an easier credit to invest in. A buoyant
economy, bouncing of cyclical troughs, improved domestic sentiment. Intelligent
pre-financing of the government borrowing needs during easy money conditions and
refocus on structural reform of the labor markets reduced perceived risks. A
manageable fiscal position and ample domestic liquidity helped Argentina to
remain as one of the top performers in 1997.
The Portfolio invested in rand denominated South African gilts as high real
interest rates and a cheap currency proved to be attractive. Interest rates were
maintained at high levels as the Central Bank sought to cool the growth in
private sector credit. The prospect of declining inflation over the course of
the year and a tight fiscal policy made the local bond market attractive. The
currency should find support from a much smaller trade balance and privatization
related inflows during 1997.
We reduced positions in Morocco as the economic recovery after the drought in
1995 was fully priced into current prices and implementation of structural
reforms seemed to be losing steam during 1997. The prospect of favorable ratings
also buoyed prices. We used the rally in prices during February to reduce our
allocations to Morocco. We will consider increasing them again once valuations
reach attractive levels and are consistent with an expected rating in the BB
category.
Brazil weathered its first concern over the currency fairly well, but doubts
over the sustainability of the current regime remain. The appearance of large
trade deficits cast doubts on the governments balance of policies. Clearly, in
the absence of a reduction in the growth of domestic demand, higher interest
rates or a tighter fiscal policy are inevitable. Privatizations and amendments
to the constitution may provide short-term relief. The government needs to
deliver on key reform initiatives this year to safeguard the long-run viability
of the Real plan.
3
<PAGE>
We reduced our allocations to Brazil as relative valuations proved to be
unattractive compared to the possible downside risks in the absence of reform.
A decline in oil prices burst Venezuela's bubble. Venezuela has benefited from
the rally in oil prices as higher oil prices have increased foreign reserves of
the Central Bank as well as improved the fiscal position of the government. A
slight delay in enacting other reform measures such as the labor and severance
pay reform bill and the granting of high adjustments to salaried workers gave
investors the excuse to take profits. Price declines were severe as the
Venezuelan story had been bought by all. We did not materially change our
exposure to Venezuela during the quarter.
The outlook for the market is dependent on the course of U.S. interest rates. At
this time it appears that another 50 basis points increase in Fed funds will be
necessary to slow demand. Higher wages and a resultant increase in unit labor
costs threatens the period of price stability that we have had since the late
1980's. Once this has been priced into the bond market and a certain amount of
stability returns to the U.S. bond market, emerging market bonds should recover.
The correction in prices has restored valuations to attractive levels. Any
further declines in the absence of any major increase in U.S. rates should prove
to be buying opportunities. A buoyant U.S. dollar, a competitive environment in
goods and labor markets in the U.S., a general lack of pricing power and the
absence of a synchronized expansion in Europe and some parts of Asia should
limit the dangers of inflation in the near term.
Paul Ghaffari
PORTFOLIO MANAGER
April 1997
4
<PAGE>
INVESTMENTS (UNAUDITED)
- ----------
MARCH 31, 1997
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------- ---------
<C> <S> <C>
DEBT INSTRUMENTS (104.0%)
ARGENTINA (22.0%)
BONDS (22.0%)
$ 2,200 Republic of Argentina BOCON,
Series D-1, 4/01/07 $ 2,539
3,300 Republic of Argentina Par Bonds,
Series L, (Step Bond), 5.00%,
3/31/23 2,065
ARP 4,700 Republic of Argentina, Series
144A, 11.75%, 2/12/07 4,727
$ 27,257 Republic of Argentina, Series L,
"Euro", (Floating Rate) 6.75%,
3/31/05 24,395
625 Republic of Argentina Global Bond,
11.375%, 1/30/17 644
---------
34,370
---------
BRAZIL (13.5%)
BONDS (13.5%)
$ 900 Federated Republic of Brazil
Discount Bond, Series Z-L,
(Floating Rate), 6.875%, 4/15/24 723
7,500 Brazil Credit Linked Enhanced Note
9.00%, 1/05/99 7,715
8,750 Federative Republic of Brazil Debt
Conversion Bond, Series Z-L,
(Floating Rate) 6.563%, 4/15/12 6,904
7,820 Federative Republic of Brazil, C
Bond, PIK, 8.00%, 4/15/04 5,823
---------
21,165
---------
BULGARIA (9.4%)
BONDS (9.4%)
$ 2,600 Bulgaria Discount Bond, Series A,
"Euro", (Floating Rate) 6.563%,
7/28/24 1,544
21,450 Bulgaria Front Loaded Interest
Reduction Bond, Series A, 2.25%,
7/28/12 9,036
7,100 Bulgaria Interest Arrears PDI
Bond, (Floating Rate) 6.563%,
7/28/11 4,060
---------
14,640
---------
ECUADOR (4.7%)
BONDS (4.7%)
$ 3,300 Ecuador Discount Bond, (Floating
Rate) 6.438%, 2/28/25 2,141
8,261 Republic of Ecuador PDI Bond,
(Floating Rate), 6.438%, 2/27/15 4,703
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------- ---------
<C> <S> <C>
$ 1,200 Republic of Ecuador Par Bond,
(Step Bond), 3.25%, 2/28/25 $ 495
---------
7,339
---------
IVORY COAST (3.5%)
LOAN AGREEMENTS (3.5%)
DEM 2,295 Ivory Coast Loan Agreement 538
FRF 59,100 Ivory Coast Loan Agreement 4,250
$ 1,800 Ivory Coast Loan Agreement 689
---------
5,477
---------
JAMAICA (2.7%)
BOND(2.7%)
4,000 Mechala Group, Jamaica, 12.75%,
12/30/99 4,140
---------
MEXICO (9.8%)
BONDS (6.4%)
$ 4,500 Empresas ICA Sociedad, Series
Regs, 11.875%, 5/30/01 4,793
ZAR 8,000 Nacional Financiera SNC, 17.00%,
2/26/99 1,783
$ 3,250 United Mexican States Global Bond,
11.50%, 5/15/26 3,364
---------
9,940
---------
NOTE (3.4%)
8,000 United Mexican States Stripped
Note, 6.375%, 9/09/97 5,377
---------
15,317
---------
PANAMA (1.3%)
BONDS (1.3%)
140 Republic of Panama Interest
Reduction Bond, "Euro", (Floating
Rate), 3.50%, 7/17/14 98
1,962 Republic of Panama Interest
Reduction Bond, (Floating Rate),
3.50%, 7/17/14 1,368
710 Republic of Panama PDI Bond,
(Floating Rate), 6.563%, 7/17/16 566
---------
2,032
---------
PERU (4.3%)
BONDS (4.3%)
7,198 Republic of Peru Front Loaded
Interest Reduction Bond, Series
US, (Step Bond), 3.25%, 3/07/17 3,725
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------- ---------
<C> <S> <C>
$ 5,235 Republic of Peru, (Step Bond),
4.00%, 3/07/17 $ 3,010
---------
6,735
---------
RUSSIA (21.7%)
BONDS (12.1%)
18,437 Ministry of Finance Tranche IV,
GDR, 3.00%, 5/14/03 11,316
4,500 Ministry of Finance Tranche IV,
"Euro", GDR, 3.00%, 5/14/03 2,762
10,100 Ministry of Finance Series VI,
GDR, 3.00%, 5/14/06 4,892
---------
18,970
---------
LOAN AGREEMENT (3.6%)
7,150 Bank for Foreign Economic Affairs,
(Floating Rate) 12/31/99
(Participation: J.P. Morgan,
Chase, and Salomon Brothers) 5,595
---------
NOTES (6.0%)
2,800 Russian Interest Arrears Note,
12/31/99 1,894
13,300 Russia Principal Notes, 12/31/99 7,481
---------
9,375
---------
33,940
---------
SOUTH AFRICA (2.3%)
BONDS (2.3%)
ZAR 18,200 Republic of South Africa, Series
150, 12.00%, 2/28/05 3,535
---------
VENEZUELA (8.8%)
BONDS (8.8%)
$ 238 Republic of Venezuela Front Loaded
Interest Reduction Bonds, Series
A, (Floating Rate) 6.75%, 3/31/07 208
8,810 Republic of Venezuela Front Loaded
Interest Reduction Bonds, Series
B, (Floating Rate), 6.75%,
3/31/07 7,683
5,200 Republic of Venezula Discount
Bonds, Series A, (Floating Rate),
6.438%, 3/31/20 4,225
2,100 Republic of Venezuela Discount
Bonds, Series B, (Floating Rate),
6.375%, 3/31/20 1,706
---------
13,822
---------
TOTAL DEBT INSTRUMENTS (Cost $166,640) 162,512
---------
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
- --------------- ---------
<C> <S> <C>
SHORT-TERM INVESTMENT (4.9%)
REPURCHASE AGREEMENT (4.9%)
U.S.$ 7,691 Chase Securities, Inc. 6.00%,
dated 3/31/97, due 4/01/97, to be
repurchased at $7,692,
collateralized by U.S. Treasury
Bonds, 11.25%, due 2/15/15,
valued at $7,849 (Cost $7,691) $ 7,691
---------
TOTAL INVESTMENTS (108.9%) (Cost $174,331) 170,203
---------
OTHER ASSETS AND LIABILITIES (-8.9%)
Other Assets 42,717
Liabilities (56,601)
---------
(13,884)
---------
NET ASSETS (100%) $ 156,319
---------
---------
CLASS A:
NET ASSETS $153,678
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 19,507,045 outstanding $0.001 par
value shares (authorized 500,000,000 shares) $7.88
---------
---------
CLASS B:
NET ASSETS $2,641
NET ASSET VALUE, OFFERING AND REDEMPTION
PRICE PER SHARE
Applicable to 335,543 outstanding $0.001 par value
shares (authorized 500,000,000 shares) $7.87
---------
---------
</TABLE>
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GDR -- GLOBAL DEPOSITARY RECEIPT.
PDI -- PAST DUE INTEREST.
PIK -- PAYMENT-IN-KIND. INCOME MAY BE PAID IN ADDITIONAL SECURITIES OR CASH AT
THE DISCRETION OF THE ISSUER.
FLOATING RATE -- INTEREST RATE CHANGES ON THESE INSTRUMENTS ARE BASED ON CHANGES
IN A DESIGNATED BASE RATE. THE RATES SHOWN ARE THOSE IN EFFECT AT MARCH 31,
1997.
STEP BOND -- COUPON RATE INCREASES IN INCREMENTS TO MATURITY. RATE DISCLOSED IS
AS OF MARCH 31, 1997. MATURITY DATE DISCLOSED IS THE ULTIMATE MATURITY.
6
