<PAGE>
MORGAN STANLEY
RUSSIA & NEW EUROPE
FUND, INC.
- ---------------------------------------------
DIRECTORS AND OFFICERS
Barton M. Biggs William G. Morton, Jr.
CHAIRMAN OF THE BOARD DIRECTOR
OF DIRECTORS Harold J. Schaaff, Jr.
Michael F. Klein VICE PRESIDENT
PRESIDENT AND DIRECTOR Joseph P. Stadler
Peter J. Chase VICE PRESIDENT
DIRECTOR Valerie Y. Lewis
John W. Croghan SECRETARY
DIRECTOR Joanna M. Haigney
David B. Gill TREASURER
DIRECTOR Belinda A. Brady
Graham E. Jones ASSISTANT TREASURER
DIRECTOR
John A. Levin
DIRECTOR
- ---------------------------------------------
INVESTMENT ADVISER
Morgan Stanley Asset Management Inc.
1221 Avenue of the Americas
New York, New York 10020
- ---------------------------------------------------------
ADMINISTRATOR
The Chase Manhattan Bank
73 Tremont Street
Boston, Massachusetts 02108
- ---------------------------------------------------------
CUSTODIAN
The Chase Manhattan Bank
Chaseside
Bournemouth BH7 7DB
United Kingdom
- ---------------------------------------------------------
SHAREHOLDER SERVICING AGENT
American Stock Transfer & Trust Company
40 Wall Street
New York, New York 10005
(800) 278-4353
- ---------------------------------------------------------
LEGAL COUNSEL
Rogers & Wells
200 Park Avenue
New York, New York 10166
- ---------------------------------------------------------
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
- ---------------------------------------------------------
For additional Fund information, including the Fund's net asset value per share
and information regarding the investments comprising the Fund's portfolio,
please call 1-800-221-6726.
----------
MORGAN STANLEY
RUSSIA & NEW EUROPE
FUND, INC.
----------
SEMI-ANNUAL REPORT
JUNE 30, 1997
MORGAN STANLEY ASSET MANAGEMENT INC.
INVESTMENT ADVISER
<PAGE>
LETTER TO SHAREHOLDERS
- --------
For the six months ended June 30, 1997, The Morgan Stanley Russia & New Europe
Fund, Inc. (the "Fund") had a total return, based on net asset value per share,
of 49.30% compared to 43.64% for the Fund's benchmark. Until a more appropriate
benchmark is created, the Fund will be compared to a market capitalization
weighted composite consisting of 50% of the Moscow Times 50 Index (dollar
adjusted) and 50% of the MSCI Czech Republic, Hungary and Poland indices. For
the period since the Fund's commencement of operations on September 30, 1996
through June 30, 1997, the Fund had a total return, based on net asset value per
share, of 55.54% compared with 57.19% for its benchmark. On June 30, 1997, the
closing price of the Fund's shares on the New York Stock Exchange was $30 3/8
representing a 2.0% discount to the Fund's net asset value per share.
The Fund's performance in the second quarter of 1997 was mainly driven by its
large Russian equity exposure of 53.6%. The Russian stock market appreciated
40.6% from March 31 to June 30, bringing the performance for the year to an
increase of 119%. Although domestic interest rates continued to decline, it was
huge international, not domestic, liquidity flows which pushed the market to its
highs. These flows came as a result of the continuing announcement of economic
reforms and the realization that from autumn Russia will be a reasonably sized
component of the emerging market indices. For example, the weighting in the IFC
Emerging Market Investable Index is expected to be 2.9%.
Russian real GDP growth looks unlikely to be significant, if existing at all,
before 1998. However, inflation remains controlled at an estimated 14% for 1997.
Recently, the new Russian cabinet started to push through some significant new
reform policies. The Russian Duma approved the first reading of a new tax code
which will dramatically simplify and re-distribute the burden of taxation in
Russia leading to better revenue collection by the government. Non-payment of
taxation remains a major problem in Russia. There are, however, some signs of
improvement on this front. The related fiscal problem of trying to control the
budget deficit was also addressed. The government announced in June that, with
or without Duma approval, a budget sequestration package would be implemented in
order to try and reach a 1997 budget deficit of 6.4%. The 1998 budget deficit
target is 4.6%. A variety of steps were also taken to try and improve the
inter-company payment problems. The international community continued to be
impressed with Russia, enabling it to successfully place its third Eurobond
issue of $2 billion at 375 basis points above US treasuries. Although largely
symbolic, Russia's entry into the G7, or G8 as it will become, is also an
important recognition of the economic progress Russia has made.
Within Russia, the Fund continues to be over-weight in the electricity sector at
23.5%, and heavily invested, but slightly underweight, in the natural resource
sector energy with a 20.2% position. The electricity sector has outperformed the
market over the last 3 months rising 56% with Unified Energy Systems (UES), the
Fund's largest position at 15.6%, increasing by 92%. Continuing signs of
restructuring at UES, which not only runs the wholesale electricity grid but
also has significant stakes in nearly every local energo, has helped push both
the sector and itself higher. Plans for new tariffs on the wholesale grid, and
the allowance only of cash settlements should also be beneficial for UES. A
further boost to the stock was a launch of an ADR program. The natural resource
sector has slightly underperformed the market, but has recently had some
positive news with the government proposing to increase oil export quotas to
those companies with heavy tax obligations to help clear this backlog.
At the end of the first quarter of 1997, we stated our intention to reduce the
Fund's Russian equity weighting to approximately 50%, as we were concerned over
some of the valuations, particularly on an operating basis, that stocks were
reaching. The recent price performance, which as said above has been liquidity
driven, has only increased this discomfort. However, we remain bullish on the
longer term view of the market and will continue to have approximately half the
Fund in Russian investments. We have also started to purchase stocks in less
well known companies and sectors. StoryFirst is a private investment in a
company which controls private, national TV networks in both Russia and the
Ukraine. Uralmash is a Russian producer of heavy earth moving machinery.
Investments such as these are, unfortunately, highly illiquid which lessens
their attractiveness, but they currently represent the best value in the region.
During May investor focus turned to the Czech Republic and the turmoil involving
its currency, the koruna. Until recently, the Czech Republic was considered by
many to be a reform "success story". The former Czechoslovak
2
<PAGE>
socialist economy was rapidly privatized in the early 1990s without the severe
dislocation associated with the "shock therapy" experienced by other countries
in the region. But lack of corporate reform, strong real wage growth and an
overvalued koruna have taken their toll. Currency turmoil in Asia sparked a
speculative attack on the koruna and after a brief battle to defend the
currency, the central bank let it float, which resulted in a precipitous drop
versus hard currencies.
The devaluation and concomitant negative sentiment set the tone for the second
quarter and the Fund's small (6.4%) weighting was justified as the market ended
down 20.4% for the second quarter and is down 21.8% for the year-to-date in
dollar terms. Since inception, the Fund has maintained a significant underweight
position in the Czech market versus the benchmark. As the Czech market has
fallen, the Fund has taken the opportunity to pick up a position in SPT, the
country's telephone monopoly. The stock's price has been dragged down by the
market's negative sentiment, but with foreign management firmly in control, the
company is one of the few examples of effective corporate restructuring.
While bearish sentiment pervades the market, Czech regulatory authorities are
making significant progress in implementing regulatory measures such as the
publication of all OTC transactions and the creation of an independent SEC-like
watch-dog. Such steps should generally improve overall investor confidence in
the Czech market.
Positive fundamentals combined with turbulence in neighboring markets pushed the
Hungarian market up 26% during the second quarter bringing its performance for
the year-to-date a rise of 56.4%. The Budapest Stock Exchange has now doubled in
size and liquidity in under a year. The Fund's current weighting in Hungary at
June 30 is 13.3%.
Hungary continues to demonstrate successful macroeconomic and corporate
restructuring. Following two years of austerity, the Hungarian economy has
returned to positive growth and GDP is rising at an accelerating pace.
Meanwhile, inflation has maintained its downward trend, allowing the central
bank to ease interest rates. Steadily improving macroeconomic fundamentals have
led to a significant improvement in the country's overall risk profile in a
relatively short period of time.
In addition to the improving economy, corporate earnings have been very strong
thus far this year. A pick up in export demand from both Western Europe and
Eastern European neighbors has boosted the market's many exporters. The central
bank continues to devalue the Hungarian forint monthly, increasing export
competitiveness. After several depressed years, real incomes have turned the
corner and are now showing signs of growth leading to a gradual increase in
consensus demand.
The Polish market, which fell 15.5% for the second quarter and 9.4%
year-to-date, has been negatively impacted by several factors. Principally, the
market has suffered from a technical imbalance. Within the space of two months,
the country's market capitalization has increased by over 20%. A flood of new
issues and the National Investment Funds (part of the government's privatization
program) starting to trade increased liquidity in the market. Demand for Polish
stock has simply not been able to keep up with supply. At June 30, 13.3% of the
Fund is currently invested in Poland.
Despite some of the new issues being fundamentally attractive, the upcoming
general election, coupled with growing concerns over the economy have kept many
investors at bay. On the political front, there is currently no political party
with a strong majority. While all the major parties have voiced their dedication
to continued privatization and economic reform, the market fears political
instability in the wake of a weak ruling party. On the economic front, it is
feared that the Polish zloty might become the target of a speculative attack,
particularly with Poland's worsening current account deficit. Both fears are
overdone and Poland's basic strengths such as strong economic growth, rising
consumer demand and large foreign inflows, remain intact. While the market may
remain weak ahead of elections, the country's improving fundamentals will
eventually push through.
In general, the Fund's investment region continues to develop positively, and
the Fund is positioned to benefit from these advances. It is hoped that in the
coming months the Fund will gain exposure to some of the less
3
<PAGE>
developed countries in the region, such as Kazakhstan and Romania, which are
becoming increasingly attractive areas for investment.
Sincerely,
/S/ MICHAEL F. KLEIN
Michael F. Klein
PRESIDENT AND DIRECTOR
/S/ MICHAEL HEWETT
Michael Hewett
PORTFOLIO MANAGER
/S/ MADHAV DHAR
Madhav Dhar
PORTFOLIO MANAGER
/S/ ROBERT L. MEYER
Robert L. Meyer
PORTFOLIO MANAGER
July 1997
- --------------------------
Robert L. Meyer has assumed co-portfolio manager responsibilities of the Fund
from Marianne L. Hay, effective April 1, 1997. Mr. Meyer is a Managing Director
of Morgan Stanley Asset Management Inc. and co-manager of MSAM's global
emerging market equity portfolios.
4
<PAGE>
Morgan Stanley Russia & New Europe Fund, Inc.
Investment Summary as of June 30, 1997 (Unaudited)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
HISTORICAL
INFORMATION
TOTAL RETURN (%)
--------------------------------------------
MARKET NET ASSET
VALUE (1) VALUE (2) INDEX (3)
---------- ---------- ----------
CUMULATIVE CUMULATIVE CUMULATIVE
---------- ---------- ----------
<S> <C> <C> <C>
FISCAL YEAR TO DATE 68.75% 49.30% 43.64%
SINCE INCEPTION* 52.35 55.54 57.19
</TABLE>
Past performance is not predictive of future performance.
- --------------------------------------------------------------------------------
RETURNS AND PER SHARE INFORMATION
[A BAR CHART REFLECTING THE DATA BELOW IS REFLECTED HERE.]
<TABLE>
<CAPTION>
TOTAL RETURN
MORGAN STANLEY RUSSIA AND NEW EUROPE FUND, INC. (2)
RUSSIA AND NEW EUROPE BLENDED COMPOSITE (3)
PERIOD FROM
SEPTEMBER 30, 1996* SIX MONTHS ENDED
TO DECEMBER 31, 1996 JUNE 30,1997
-------------------- ----------------
<S> <C> <C>
Net Asset Value Per Share $ 20.77 $ 31.01
Market Value Per Share $18.00 $30.38
Premium/(Discount) -13.3% 2.0%
Income Dividends $0.07 --
Capital Gains Distributions -- --
Fund Total Return (2) 4.18% 49.30%
Index Total Return (3) 9.43% 43.64%
</TABLE>
(1) Assumes dividends and distributions, if any, were reinvested.
(2) Total investment return based on net asset value per share reflects the
effects of changes in net asset value on the performance of the Fund during
each period, and assumes dividends and distributions, if any, were
reinvested. These percentages are not an indication of the performance of a
shareholder's investment in the Fund based on market value due to
differences between the market price of the stock and the net asset value
per share of the Fund.
(3) The Russia and New Europe Blended Composite is a capitalization weighted
index comprised of the Morgan Stanley Capital International regional indices
for the Czech Republic, Hungary, Poland and the Moscow Times 50 Index,
including dividends.
* The Fund commenced operations on September 30, 1996.
5
<PAGE>
Morgan Stanley Russia & New Europe Fund, Inc.
Portfolio Summary as of June 30, 1997 (Unaudited)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PORTFOLIO INVESTMENTS DIVERSIFICATION
[EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC]
<TABLE>
<S> <C>
Equity Securities 92.6%
Debt Instruments 7.0%
Short-Term Invest-
ments 0.4%
</TABLE>
- --------------------------------------------------------------------------------
SECTORS
[EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC]
<TABLE>
<S> <C>
Banking 4.0%
Data Processing & Reproduction 2.6%
Energy Sources 25.5%
Financial Services 2.6%
Foreign Government Bonds 3.8%
Health & Personal Care 3.4%
Merchandising 4.0%
Telecommunications 9.8%
Utilities - Electrical & Gas 23.5%
Other 20.8%
</TABLE>
- --------------------------------------------------------------------------------
COUNTRY WEIGHTINGS
[EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC]
<TABLE>
<S> <C>
Russia 60.4%
Poland 13.3%
Hungary 13.3%
Czech Repub-
lic 6.4%
Croatia 2.9%
Slovakia 1.0%
Other 2.7%
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS*
PERCENT OF
NET ASSETS
----------
<C> <S> <C>
1. Unified Energy System 15.6%
2. Lukoil Holdings 6.5
3. Surgutneftegaz 6.0
4. Republic of Russia Debt 5.5
5. MOL Magyar Olaj-es Gazipari Rt. 4.8
<CAPTION>
PERCENT OF
NET ASSETS
----------
<C> <S> <C>
6. Moscow Energy 4.8%
7. SPT Telecom 4.1
8. Rostelecom 3.9
9. Tatneft ADR 2.8
10. Richter Gedeon Rt. 2.3
-----
56.3%
-----
-----
</TABLE>
* Excludes short-term investments.
6
<PAGE>
FINANCIAL STATEMENTS
- ---------
STATEMENT OF NET ASSETS (UNAUDITED)
- ---------
JUNE 30, 1997
<TABLE>
<CAPTION>
VALUE
SHARES (000)
<S> <C> <C>
- -----------------------------------------------------------------------------
- ------------
COMMON STOCKS (90.5%)
(Unless otherwise noted)
- -----------------------------------------------------------------------------
- ------------
CROATIA (2.9%)
BANKING
(a)Zagrebacka Banka GDR 90,500 U.S.$ 2,930
-------------
HEALTH & PERSONAL CARE
(a)Pliva d.d. GDR 104,500 1,588
-------------
4,518
-------------
- -----------------------------------------------------------------------------
- ------------
CZECH REPUBLIC (6.4%)
FINANCIAL SERVICES
PF IKS KB 150,000 695
(a)Resolution Investment Fund 26,100 632
(a)Zivnobanka - Investicni Fond 50,000 654
-------------
1,981
-------------
MACHINERY & ENGINEERING
(a)CKD Praha Holding 23,656 644
(a)Skoda Plzen 36,500 1,092
-------------
1,736
-------------
TELECOMMUNICATIONS
(a)SPT Telekom 60,000 6,294
-------------
10,011
-------------
- -----------------------------------------------------------------------------
- ------------
HUNGARY (13.3%)
AUTOMOBILES
(a)Mezogep 90,000 1,166
-------------
BUILDING MATERIALS & COMPONENTS
Zalakeramia Rt. 46,000 1,781
-------------
CHEMICALS
(a)BorsodChem Rt. GDR 63,000 2,449
-------------
ENERGY SOURCES
(a)MOL Magyar Olaj-es Gazipari Rt. 375,000 7,481
Primagaz Rt. 16,000 872
-------------
8,353
-------------
HEALTH & PERSONAL CARE
Richter Gedeon Rt. GDS 39,300 3,615
-------------
MISCELLANEOUS MATERIALS & COMMODITIES
Pannonplast Rt. 16,825 845
-------------
PHARMACEUTICALS
EGIS Rt. 31,000 1,978
-------------
MERCHANDISING
(a)Fotex Rt. 422,570 472
-------------
20,659
-------------
- -----------------------------------------------------------------------------
- ------------
POLAND (13.3%)
AUTOMOBILES
(a)Sanockie Zaklady Przemyslu Gumowego Stomil 51,986 997
(a)Stomil Olsztyn 35,000 335
-------------
1,332
-------------
<CAPTION>
VALUE
SHARES (000)
- -----------------------------------------------------------------------------
- ------------
<S> <C> <C>
BANKING
BIG 1,275,000 U.S.$ 1,532
(a)Bank Handlowy W Warszawie 41,400 441
Bank Slaski 17,600 1,259
-------------
3,232
-------------
BUILDING MATERIALS & COMPONENTS
(a)Polifarb Cieszyn 155,000 787
Polifarb Wroclaw 215,000 805
-------------
1,592
-------------
CONSTRUCTION & HOUSING
(a)Budimex 165,000 1,506
-------------
DATA PROCESSING & REPRODUCTION
(a)Computerland Poland 100,900 2,487
(a)OPTIMUS 'D' 57,466 1,609
-------------
4,096
-------------
ENERGY EQUIPMENT & SERVICES
(a)Elektrobudowa 60,000 958
-------------
FINANCIAL SERVICES
(a)National Investment Fund GDR 50,000 2,125
-------------
FOOD & HOUSEHOLD PRODUCTS
(a)Farm Food 112,450 1,540
Sokolowskie Zaklady Miesne 683,750 957
-------------
2,497
-------------
MERCHANDISING
(e)Best 107,000 1,302
-------------
MULTI-INDUSTRY
Elektrim Spolka Akcyjna 236,000 2,054
-------------
20,694
-------------
- -----------------------------------------------------------------------------
- ------------
RUSSIA (53.6%)
ENERGY SOURCES
(a)Lukoil Holdings 370,000 7,263
(a)Lukoil Holdings (Preferred) 230,000 2,887
(a)Megionneftegas 150,000 1,076
(a)Noyabrskneftegaz 270,000 2,977
(a)Orenburgneft 60,000 411
(a)Purneftegaz 485,000 2,740
Surgutneftegaz ADR 175,000 9,362
(a)Tatneft ADR 41,200 4,388
(a)Urdmurtneft 3,500 201
-------------
31,305
-------------
MACHINERY & ENGINEERING
(a)Uralmash Rursoo 22,238 569
-------------
MERCHANDISING
(a)TSUM 3,650,000 2,865
-------------
METALS -- NON-FERROUS
(a)Norilsk Nickel 166,000 1,569
(a)Norilsk Nickel (Preferred) 100,000 540
-------------
2,109
-------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
7
<PAGE>
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- -----------------------------------------------------------------------------
- ------------
<S> <C> <C>
METALS -- STEEL
(a)Seversky Tube Works 200,000 U.S.$ 570
(a)Seversky Tube Works ADR 10,000 286
-------------
856
-------------
TELECOMMUNICATIONS
(a)Nizhny Novgorod Telephone 200,000 990
(a)Rostelecom 1,580,000 6,130
St. Petersburg Telephone Network 1,100,000 1,859
-------------
8,979
-------------
UTILITIES -- ELECTRICAL & GAS
(a)Gazprom ADS 97,700 1,619
(a)Irkutskenergo 4,000,000 1,362
(a)Lenenergo 1,800,000 1,485
(a)Moscow Energy 5,275,000 7,390
(a)Unified Energy System(UES) 66,800,000 24,175
(a)Permenergo 9,000 405
-------------
36,436
-------------
83,119
-------------
- -----------------------------------------------------------------------------
- ------------
SLOVAKIA (1.0%)
CHEMICALS
(a)Slovnaft 60,000 1,481
-------------
- -----------------------------------------------------------------------------
- ------------
TOTAL COMMON STOCKS
(Cost U.S. $95,583) 140,482
-------------
</TABLE>
- -----------------------------------------------------------------------------
- ------------
<TABLE>
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
<S> <C> <C>
- -----------------------------------------------------------------------------
- ------------
DEBT INSTRUMENTS (6.8%)
- -----------------------------------------------------------------------------
- ------------
RUSSIA (6.8%)
BONDS (3.8%)
Ministry of Finance Tranche IV 3.00%, 5/14/03 U.S.$6,000 4,026
(e)Storyfirst Communications Tranche III
(Convertible) 2 1,938
-------------
5,964
-------------
LOAN AGREEMENTS (3.0%)
(b,c,d)Bank for Foreign Economic Affairs
(Participation: Chase Securities, Inc.) 5,000 4,587
-------------
- -----------------------------------------------------------------------------
- ------------
TOTAL DEBT INSTRUMENTS
(Cost U.S. $9,718) 10,551
-------------
- -----------------------------------------------------------------------------
- ------------
SHORT-TERM INVESTMENT (0.4%)
- -----------------------------------------------------------------------------
- ------------
UNITED STATES (0.4%)
REPURCHASE AGREEMENT
Chase Securities, Inc. 5.70%, dated 6/30/97, due
7/1/97 to be repurchased at U.S.$618,
collateralized by United States Treasury
Bonds, 5.625%, due 2/15/06, valued at U.S.$629
(Cost U.S.$618) 618 618
-------------
- -----------------------------------------------------------------------------
- ------------
TOTAL INVESTMENTS (97.7%)
(Cost U.S. $105,919) 151,651
-------------
<CAPTION>
- -----------------------------------------------------------------------------
- ------------
AMOUNT AMOUNT
(000) (000)
- -----------------------------------------------------------------------------
- ------------
<S> <C> <C>
OTHER ASSETS (3.4%)
Cash U.S.$3,036
Receivable for Investments Sold 1,461
Interest Receivable 492
Dividends Receivable 167
Deferred Organization Costs 68
Other Assets 13 U.S.$ 5,237
---------- -------------
- -----------------------------------------------------------------------------
- ------------
LIABILITIES (-1.1%)
Payable for:
Custodian Fees (715)
Investments Purchased (569)
Investment Advisory Fees (184)
Shareholder Reporting Expense (105)
Professional Fees (56)
Administrative Fees (16)
Directors' Fees and Expenses (12)
Other Liabilities (13) (1,670)
---------- -------------
- -----------------------------------------------------------------------------
- ------------
NET ASSETS (100%)
Applicable to 5,005,000 issued and outstanding U.S. $0.01
par value shares (500,000,000 shares authorized) U.S.$ 155,218
-------------
-------------
- -----------------------------------------------------------------------------
- ------------
NET ASSET VALUE PER SHARE U.S.$ 31.01
-------------
-------------
- -----------------------------------------------------------------------------
- ------------
AT JUNE 30, 1997, NET ASSETS CONSISTED OF:
- ---------------------------------------------------------
Common Stock U.S.$ 50
Capital Surplus 100,050
Accumulated Net Investment Loss (608)
Accumulated Net Realized Gain 10,009
Unrealized Appreciation on Investments and Foreign Currency
Translations 45,717
- -----------------------------------------------------------------------------
- ------------
TOTAL NET ASSETS U.S.$ 155,218
-------------
-------------
- -----------------------------------------------------------------------------
- ------------
</TABLE>
(a) -- Non-income producing.
(b) -- Non-income producing - in default.
(c) -- Participation interests were acquired through the financial institution
listed parenthetically.
(d) -- Under restructuring at June 30, 1997.-See note A-6 to financial
statements.
(e) -- Security fair valued at cost.
ADR -- American Depositary Receipt.
ADS -- American Depositary Shares.
GDR -- Global Depositary Receipt.
GDS -- Global Depositary Shares.
The accompanying notes are an integral part of the financial statements.
8
<PAGE>
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
JUNE 30, 1997
(UNAUDITED)
STATEMENT OF OPERATIONS (000)
<S> <C>
- ---------------------------------------------------------------------------------------------------------
INVESTMENT INCOME
Dividends............................................................................. U.S.$ 184
Interest.............................................................................. 1,100
Less: Foreign Taxes Withheld.......................................................... (46)
- ---------------------------------------------------------------------------------------------------------
Total Income........................................................................ 1,238
- ---------------------------------------------------------------------------------------------------------
EXPENSES
Investment Advisory Fees.............................................................. 1,088
Custodian Fees........................................................................ 451
Administrative Fees................................................................... 97
Shareholder Reporting Expenses........................................................ 81
Professional Fees..................................................................... 53
Directors' Fees and Expenses.......................................................... 15
Other Expenses........................................................................ 51
- ---------------------------------------------------------------------------------------------------------
Total Expenses...................................................................... 1,836
- ---------------------------------------------------------------------------------------------------------
Net Investment Loss............................................................... (598)
- ---------------------------------------------------------------------------------------------------------
NET REALIZED GAIN (LOSS)
Investment Securities Sold............................................................ 9,761
Foreign Currency Transactions......................................................... (127)
- ---------------------------------------------------------------------------------------------------------
Net Realized Gain................................................................. 9,634
- ---------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION/DEPRECIATION
Appreciation on Investments........................................................... 42,252
Depreciation on Foreign Currency Translation.......................................... (15)
- ---------------------------------------------------------------------------------------------------------
Change in Unrealized Appreciation/Depreciation.................................... 42,237
- ---------------------------------------------------------------------------------------------------------
Total Net Realized Gain and Change in Unrealized Appreciation/Depreciation................ 51,871
- ---------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS.................................. U.S.$ 51,273
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS
ENDED PERIOD FROM
JUNE 30, 1997 SEPTEMBER 30, 1996*
(UNAUDITED) TO DECEMBER 31, 1996
STATEMENT OF CHANGES IN NET ASSETS (000) (000)
<S> <C> <C>
- --------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
Operations:
Net Investment Income (Loss)........................................ U.S.$ (598) U.S.$ 293
Net Realized Gain................................................... 9,634 397
Change in Unrealized Appreciation/Depreciation...................... 42,237 3,480
- --------------------------------------------------------------------------------------------------------------
Net Increase in Net Assets Resulting from Operations................ 51,273 4,170
- --------------------------------------------------------------------------------------------------------------
Distributions:
Net Investment Income............................................... -- (325)
- --------------------------------------------------------------------------------------------------------------
Capital Share Transactions:
Common Stock Issued through Initial Public Offering (5,005,000)..... -- 100,100
- --------------------------------------------------------------------------------------------------------------
Total Increase...................................................... 51,273 103,945
Net Assets:
Beginning of Period................................................. 103,945 --
- --------------------------------------------------------------------------------------------------------------
End of Period (including accumulated net investment loss of U.S.$608
and distributions in excess of net investment income of U.S.$10,
respectively)...................................................... U.S.$155,218 U.S.$103,945
- --------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------
*Commencement of Operations
</TABLE>
The accompanying notes are an integral part of the financial statements.
9
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
SIX MONTHS
ENDED PERIOD FROM
JUNE 30, 1997 SEPTEMBER 30, 1996*
SELECTED PER SHARE DATA AND RATIOS: (UNAUDITED) TO DECEMBER 31, 1996
<S> <C> <C>
- -------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD.................................... U.S.$ 20.77 U.S.$ 20.00
- -------------------------------------------------------------------------------------------------------------------
Net Investment Income (Loss)............................................ (0.12) 0.06
Net Realized and Unrealized Gain on Investments......................... 10.36 0.78
- -------------------------------------------------------------------------------------------------------------------
Total from Investment Operations.................................... 10.24 0.84
- -------------------------------------------------------------------------------------------------------------------
Distributions:
Net Investment Income............................................... -- (0.07)
- -------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD.......................................... U.S.$ 31.01 U.S.$ 20.77
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
PER SHARE MARKET VALUE, END OF PERIOD................................... U.S.$ 30.38 U.S.$ 18.00
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:
Market Value........................................................ 68.75% (9.72)%
Net Asset Value (1)................................................. 49.30% 4.18%
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
RATIOS, SUPPLEMENTAL DATA:
- -------------------------------------------------------------------------------------------------------------------
NET ASSETS, END OF PERIOD (THOUSANDS)................................... U.S.$ 155,218 U.S.$ 103,945
- -------------------------------------------------------------------------------------------------------------------
Ratio of Expenses to Average Net Assets................................. 2.69%** 3.30%**
Ratio of Net Investment Income to Average Net Assets.................... (0.88)%** 1.15%**
Portfolio Turnover Rate................................................. 33% 2%
Average Commission Rate:
Per Share........................................................... U.S.$ 0.0053 U.S.$ 0.0456
As a Percentage of Trade Amount..................................... 0.49% 0.59%
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
*Commencement of Operations.
**Annualized.
(1)Total investment return based on net asset value per share reflects the
effects of changes in net asset value on the performance of the Fund during
each period, and assumes dividends and distributions, if any, were
reinvested. These percentages are not an indication of the performance of a
shareholder's investment in the Fund based on market value due to differences
between the market price of the stock and the net asset value of the Fund.
The accompanying notes are an integral part of the financial statements.
10
<PAGE>
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1997 (UNAUDITED)
- ------------
The Morgan Stanley Russia & New Europe Fund, Inc. (the "Fund") was
incorporated in Maryland on February 3, 1994 and is registered as a
non-diversified, closed-end management investment company under the Investment
Company Act of 1940, as amended. The Fund's investment objective is long-term
capital appreciation through investments primarily in equity securities.
A. The following significant accounting policies, which are in conformity with
generally accepted accounting principles for investment companies, are
consistently followed by the Fund in the preparation of its financial
statements. Generally accepted accounting principles may require management to
make estimates and assumptions that affect the amounts and disclosures in the
financial statements. Actual reported results may differ from those estimates.
1. SECURITY VALUATION: In valuing the Fund's assets, all listed securities for
which market quotations are readily available are valued at the last sales
price on the valuation date, or if there was no sale on such date, at the
mean between the current bid and asked prices. Securities which are traded
over-the-counter are valued at the average of the mean of current bid and
asked prices obtained from reputable brokers. All non-equity securities as
to which market quotations are readily available are valued at their market
values. Short-term securities which mature in 60 days or less are valued at
amortized cost. All other securities and assets for which market values are
not readily available (including investments which are subject to
limitations as to their sale) are valued at fair value as determined in good
faith by the Board of Directors (the "Board"), although the actual
calculations may be done by others.
2. TAXES: It is the Fund's intention to continue to qualify as a regulated
investment company and distribute all of its taxable income. Accordingly, no
provision for U.S. Federal income taxes is required in the financial
statements.
The Fund may be subject to taxes imposed by countries in which it invests.
Such taxes are generally based on income and/or capital gains earned or
repatriated. Taxes are accrued and applied to net investment income, net
realized gains and net unrealized appreciation as such income and/or gains
are earned.
3. REPURCHASE AGREEMENTS: In connection with transactions in repurchase
agreements, a bank as custodian for the Fund takes possession of the
underlying securities, with a market value at least equal to the amount of
the repurchase transaction, including principal and accrued interest. To the
extent that any repurchase transaction exceeds one business day, the value
of the collateral is marked-to-market on a daily basis to determine the
adequacy of the collateral. In the event of default on the obligation to
repurchase, the Fund has the right to liquidate the collateral and apply the
proceeds in satisfaction of the obligation. In the event of default or
bankruptcy by the counterparty to the agreement, realization and/or
retention of the collateral or proceeds may be subject to legal proceedings.
4. FOREIGN CURRENCY TRANSLATION: The books and records of the Fund are
maintained in U.S. dollars. Foreign currency amounts are translated into
U.S. dollars at the mean of the bid and asked prices of such currencies
against U.S. dollars last quoted by a major bank as follows:
- investments, other assets and liabilities at the prevailing rates of
exchange on the valuation date;
- investment transactions and investment income at the prevailing rates of
exchange on the dates of such transactions.
Although the net assets of the Fund are presented at the foreign exchange
rates and market values at the close of the period, the Fund does not
isolate that portion of the results of operations arising as a result of
changes in the foreign exchange rates from the fluctuations arising from
changes in the market prices of the securities held at period end.
Similarly, the Fund does not isolate the effect of changes in foreign
exchange rates from the fluctuations arising from changes in the market
prices of securities sold during the period. Accordingly, realized and
unrealized foreign currency gains (losses) are included in the reported net
realized and unrealized gains (losses) on investment transactions and
balances.
Net realized gains (losses) on foreign currency transactions represent net
foreign exchange gains (losses) from sales and maturities of foreign
currency exchange contracts, disposition of foreign currencies, currency
gains or losses realized between the trade and settlement dates on
securities transactions, and the difference between the amount of investment
income and foreign withholding taxes recorded on the Fund's books and the
U.S. dollar equivalent amounts actually received or paid. Net unrealized
currency gains (losses) from valuing foreign currency denominated assets and
liabilities at period end exchange rates are reflected as a component of
unrealized appreciation (depreciation) on investments and foreign
11
<PAGE>
currency translations in the Statement of Net Assets. The change in net
unrealized currency gains (losses) for the period is reflected in the
Statement of Operations.
5. FOREIGN CURRENCY EXCHANGE CONTRACTS: The Fund may enter into foreign
currency exchange contracts to attempt to protect securities and related
receivables and payables against changes in future foreign exchange rates. A
foreign currency exchange contract is an agreement between two parties to
buy or sell currency at a set price on a future date. The market value of
the contract will fluctuate with changes in currency exchange rates. The
contract is marked-to-market daily and the change in market value is
recorded by the Fund as unrealized gain or loss. The Fund records realized
gains or losses when the contract is closed equal to the difference between
the value of the contract at the time it was opened and the value at the
time it was closed. Risk may arise upon entering into these contracts from
the potential inability of counterparties to meet the terms of their
contracts and is generally limited to the amount of unrealized gain on the
contracts, if any, at the date of default. Risks may also arise from
unanticipated movements in the value of a foreign currency relative to the
U.S. dollar.
6. LOAN AGREEMENTS: The Fund may invest in fixed and floating rate loans
("Loans") arranged through private negotiations between an issuer of
sovereign debt obligations and one or more financial institutions
("Lenders") deemed to be creditworthy by the investment adviser. The Fund's
investments in Loans may be in the form of participations in Loans
("Participations") or assignments of all or a portion of Loans
("Assignments") from third parties. The Fund's investment in Participations
typically results in the Fund having a contractual relationship with only
the Lender and not with the borrower. The Fund has the right to receive
payments of principal, interest and any fees to which it is entitled only
from the Lender selling the Participation and only upon receipt by the
Lender of the payments from the borrower. The Fund generally has no right to
enforce compliance by the borrower with the terms of the loan agreement. As
a result, the Fund may be subject to the credit risk of both the borrower
and the Lender that is selling the Participation. When the Fund purchases
Assignments from Lenders it acquires direct rights against the borrower on
the Loan. Because Assignments are arranged through private negotiations
between potential assignees and potential assignors, the rights and
obligations acquired by the Fund as the purchaser of an Assignment may
differ from, and be more limited than, those held by the assigning Lender.
7. OTHER: Security transactions are accounted for on the date the securities
are purchased or sold. Realized gains and losses on the sale of investment
securities are determined on the specific identified cost basis. Interest
income is recognized on the accrual basis. Dividend income is recorded on
the ex-date (except certain dividends which may be recorded as soon as the
Fund is informed of such dividends) net of applicable withholding taxes
where recovery of such taxes is not reasonably assured.
The amount and character of income and capital gain distributions to be paid
are determined in accordance with Federal income tax regulations which may
differ from generally accepted accounting principles. These differences are
primarily due to differing book and tax treatments for foreign currency
transactions, gains on certain securities of corporations designated as
"passive foreign investment companies" and the timing of the recognition of
gains or losses on securities.
Permanent book and tax basis differences relating to shareholder
distributions may result in reclassifications to undistributed net
investment income (loss), accumulated net realized gain (loss) and capital
surplus.
Adjustments for permanent book-tax differences, if any, are not reflected in
ending undistributed net investment income (loss) for the purpose of
calculating net investment income (loss) per share in the financial
highlights.
B. Morgan Stanley Asset Management Inc. (the "Adviser") provides investment
advisory services to the Fund under the terms of an Investment Advisory
Agreement (the "Agreement"). Under the Agreement, the Adviser is paid a fee
computed weekly and payable monthly at an annual rate of 1.60% of the Fund's
average weekly net assets.
C. The Chase Manhattan Bank, through its affiliate Chase Global Funds Services
Company (the "Administrator"), provides administrative services to the Fund
under an Administration Agreement. Under the Administration Agreement, the
Administrator is paid a fee computed weekly and payable monthly at an annual
rate of 0.09% of the Fund's average weekly net assets, plus $65,000 per annum.
In addition, the Fund is charged certain out-of-pocket expenses by the
Administrator. The Chase Manhattan Bank acts as global custodian for the Fund's
assets.
12
<PAGE>
D. For the six months ended June 30, 1997, the Fund made purchases and sales
totaling $59,718,000 and $41,156,000, respectively, of investment securities
other than long-term U.S. Government securities and short-term investments.
These were no purchases or sales of long-term U.S. Government securities. At
June 30, 1997, the U.S. Federal income tax cost basis of securities was
$105,919,000 and accordingly, net unrealized appreciation for U.S. Federal
income tax purposes was $45,732,000, of which $50,369,000 related to appreciated
securities and $4,637,000 related to depreciated securities.
E. A significant portion of the Fund's assets consist of securities of issues
located in emerging markets, which are denominated in foreign currencies.
Changes in currency exchange rates will affect the value of and investment
income from such securities. Securities in emerging markets involve certain
considerations and risks not typically associated with investments in the United
States. In addition to smaller size, lesser liquidity and greater volatility,
certain securities' markets in which the Fund may invest are less developed than
the U.S. securities market and there is often substantially less publicly
available information about these issuers. Further, emerging market issues may
be subject to substantial governmental involvement in the economy and greater
social, economic and political uncertainty. Accordingly, the price which the
Fund may realize upon sale of securities in such markets may not be equal to its
value as presented in the financial statements.
Settlement and registration of securities transactions may be subject to
significant risks not normally associated with investments in the United States.
In certain markets, including Russia, ownership of shares is defined according
to entries in the issuer's share register. In Russia, there currently exists no
central registration system and the share registrars may not be subject to
effective state supervision. It is possible the Fund could lose its share
registration through fraud, negligence or even mere oversight.
F. In connection with its organization the Fund incurred $80,000 of
organization costs. The organization costs are being amortized on a
straight-line basis over a five year period beginning September 30, 1996, the
date the Fund commenced operations.
G. The Fund entered into an Agreement with a number of underwriters (the
"Underwriters") including Morgan Stanley & Co. Incorporated, an affiliate of the
Adviser, for the initial public offering of its shares and issued 5,005,000
shares on September 30, 1996. In connection with the initial offering of the
Fund's shares, the Adviser has agreed to pay the related offering costs totaling
approximately $420,000. In addition, the Adviser agreed to pay the underwriters
of the offering a commission equal to 4% of the initial public offering price
per share, other than for shares acquired for accounts managed by the Adviser.
H. Each Director of the Fund who is not an officer of the Fund or an affiliated
person as defined under the Investment Company Act of 1940, as amended, may
elect to participate in the Directors' Deferred Compensation Plan (the "Plan").
Under the Plan, such Directors may elect to defer payment of a percentage of
their total fees earned as a Director of the Fund. These deferred portions are
treated, based on an election by the Director, as if they were either invested
in the Fund's shares or invested in U.S. Treasury Bills, as defined under the
Plan. The deferred fees payable, under the Plan, at June 30, 1997 totaled $6,000
and are included in Payable for Directors' Fees and Expenses on the Statement of
Net Assets.
I. Supplemental Proxy Information
The Annual Meeting of the Stockholders of The Morgan Stanley Russia & New Europe
Fund, Inc. was held on April 30, 1997. The following is a summary of each
proposal presented and the total number of shares voted:
<TABLE>
<CAPTION>
VOTES IN VOTES VOTES VOTES
PROPOSAL: FAVOR OF AGAINST WITHHELD ABSTAINED
- -------------------------------------------------------------------------------- --------- ------- -------- ---------
<S> <C> <C> <C> <C>
1. To elect the following Directors: John W. Croghan 3,819,398 27,449 -- --
Graham E. Jones 3,819,398 27,449 -- --
2. To ratify the selection of Price Waterhouse LLP as independent public
accountants of the Fund. 3,821,168 21,800 -- 3,879
3. To approve an Investment Advisory and Management Agreement between the Fund
and Morgan Stanley Asset Management, Inc. 3,810,767 29,579 -- 6,501
</TABLE>
13
<PAGE>
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
Pursuant to the Dividend Reinvestment and Cash Purchase Plan (the "Plan"),
each shareholder will be deemed to have elected, unless American Stock Transfer
& Trust Company (the "Plan Agent") is otherwise instructed by the shareholder in
writing, to have all distributions automatically reinvested in Fund shares.
Participants in the Plan have the option of making additional voluntary cash
payments to the Plan Agent, annually, in any amount from $100 to $3,000, for
investment in Fund shares.
Dividend and capital gain distributions will be reinvested on the
reinvestment date in full and fractional shares. If the market price per share
equals or exceeds net asset value per share on the reinvestment date, the Fund
will issue shares to participants at net asset value. If net asset value is less
than 95% of the market price on the reinvestment date, shares will be issued at
95% of the market price. If net asset value exceeds the market price on the
reinvestment date, participants will receive shares valued at market price. The
Fund may purchase shares of its Common Stock in the open market in connection
with dividend reinvestment requirements at the discretion of the Board of
Directors. Should the Fund declare a dividend or capital gain distribution
payable only in cash, the Plan Agent will purchase Fund shares for participants
in the open market as agent for the participants.
The Plan Agent's fees for the reinvestment of dividends and distributions
will be paid by the Fund. However, each participant's account will be charged a
pro rata share of brokerage commissions incurred on any open market purchases
effected on such participant's behalf. A participant will also pay brokerage
commissions incurred on purchases made by voluntary cash payments. Although
shareholders in the Plan may receive no cash distributions, participation in the
Plan will not relieve participants of any income tax which may be payable on
such dividends or distributions.
In the case of shareholders, such as banks, brokers or nominees, which hold
shares for others who are the beneficial owners, the Plan Agent will administer
the Plan on the basis of the number of shares certified from time to time by the
shareholder as representing the total amount registered in the shareholder's
name and held for the account of beneficial owners who are participating in the
Plan.
Participants who wish to withdraw from the Plan should notify the Plan Agent
in writing. There is no penalty for non-participation or withdrawal from the
Plan, and shareholders who have previously withdrawn from the Plan may rejoin at
any time. Requests for additional information or any correspondence concerning
the Plan should be directed to the Plan Agent at:
Morgan Stanley Russia & New Europe Fund, Inc.
American Stock Transfer & Trust Company
Dividend Reinvestment and Cash Purchase Plan
40 Wall Street
New York, NY 10005
1-800-278-4353
14
