<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 Michael F. Klein
Warren J. Olsen VICE PRESIDENT
PRESIDENT AND DIRECTOR Harold J. Schaaff, Jr.
Peter J. Chase VICE PRESIDENT
DIRECTOR Joseph P. Stadler
John W. Croghan VICE PRESIDENT
DIRECTOR Valerie Y. Lewis
David B. Gill SECRETARY
DIRECTOR James R. Rooney
Graham E. Jones TREASURER
DIRECTOR Belinda A. Brady
John A. Levin ASSISTANT TREASURER
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.
----------
FIRST QUARTER REPORT
MARCH 31, 1997
MORGAN STANLEY ASSET MANAGEMENT INC.
INVESTMENT ADVISER
<PAGE>
LETTER TO SHAREHOLDERS
- --------
For the three months ended March 31, 1997, the Morgan Stanley Russia & New
Europe Fund, Inc. (the "Fund") had a total return, based on net asset value per
share, of 30.72% compared to 29.95% for the Fund's benchmark. Until a more
appropriate benchmark is created, the Fund will be compared to a composite
consisting of 50% of the Moscow Times 50 Index (dollar adjusted) and 50% of the
MSCI Czech Republic, Hungary and Poland indices (weighted by market
capitalization). For the period since the Fund's commencement of operations on
September 30, 1996 through March 31, 1997, the Fund had a total return, based on
net asset value per share, of 36.17% compared with 42.20% for its benchmark. On
March 31, 1997, the closing price of the Fund's shares on the New York Stock
Exchange was $23 7/8 representing a 12.0% discount to the Fund's net asset value
per share.
The first quarter was positive for the most of Fund's main target markets
(Hungary was up 24.2% and Poland was up 7.3%), but particularly strong for
Russia where the market appreciated by 56%. This impressive performance was
driven at the start of the year by international capital flows which, for the
first time, were re-enforced in February by domestic Russian institutional
buying as the yield on Russian fixed income products fell. Nervousness in the
international developed markets, combined with apprehensions about the speed of
the rise in Eastern European and Russian markets, caused a correction across the
region with Hungary closing the quarter 6.6% off its high and Russia falling by
9% in March. The Fund was fully invested by early February, but concerns about
such a correction led to a raising of cash in early March. At the quarter end,
cash accounted for 11.6% of the Fund's net assets.
The most encouraging Russian news of 1997 is the return to health of President
Yeltsin enabling him to appoint a youthful, highly reform oriented cabinet,
including the widely respected Anatoly Chubais and Boris Nemtsov. Russia still
faces major challenges at both a macro and micro level. Despite last year's
successes, such as reducing inflation (15% expected in 1997) and lowering
interest rates (now down to around 30%), Russia has yet to experience official
GDP growth (expectations are for +1% in 1997). Of course, Russia has a large
grey economy, perhaps 40% of official GDP, which has been growing, but the
un-recorded nature of such activity does not help the country's continuing tax
and payment problems. The only hope for bringing this section of the economy
into the open is for further reform, especially of the highly arbitrary tax
system. The payment situation will only improve when further liberalization
occurs in areas such as the utilities sector where inefficiencies are still rife
and industrial rates egregiously high. The good news is that the new government
has not only stated its intention to tackle these problems but has also started
to act, with work beginning on a new tax code and open scrutiny of the
monopolies in the utility sector. International institutions continue to support
the country with the International Monetary Fund (IMF) stating their intention
to re-start lending from a $10 billion stand-by facility and the World Bank
arranging a $6 billion loan. The bad news is that there simply is no quick fix
to these problems, and the Russian population will have to face yet more painful
policies.
The Fund is positioned to take advantage of these reforms. The portfolio is
overweight in the electrical utility sector (19.1%) with the largest exposure
being to UES (9.4%) the hugely inefficient Russian electricity monopoly which
not only owns and controls the electrical wholesale grid but also has stakes in
nearly all major local electricity companies. Hopes of reform in the sector have
already led to price appreciation of 111% in the first quarter of the year, but
a credible reform program will unlock much more value from this behemoth. The
oil and gas sector continues to be an area of great potential. The sector is
currently the most highly taxed of any in Russia and a new tax code will help
the profitability of all oil companies. This prospect combined with the ability
to access the international oil market while the domestic one develops makes the
natural resource area one of the most exciting in Russia, despite the recent
fall in the international oil price.
Although information is improving, valuation remains more an art than a science
in Russia. Most liquid stocks still trade at asset valuations which are
significantly discounted to their Western counterparts (e.g. well over 50%).
However, with the recent performance of the market, operating multiples (where
they exist) are similar to other, high growth emerging markets with
P/E's frequently in the mid-teens. The conclusion, therefore, is that while
Russia still has extraordinary mid-to long-term potential, in the shorter term,
major challenges exist and many of these future prospects are considered in the
price of equities. Perhaps the main advantage of a smaller sized regional fund
is the ability to re-allocate resources away from a country with limited
short-term potential, but to still be able to re-invest quickly should the
market turn. We have, therefore, recently reduced the Fund's exposure to Russian
equities to just over 50%.
The positive long-term outlook for the Polish economy was reinforced by an
announcement that GDP grew 6% last year and inflation gradually declined.
Poland's ties with the West continued to intensify as the
2
<PAGE>
government pushes for entry into NATO and the European Union. While the top-down
perspective remains favorable, the market has been distressed by two concerns --
credit growth and capital increases. The Central Bank warned that triple-digit
increases in consumer credit could lead to higher interest rates in the
short-term. While the Central Bank increased reserve requirements in January and
short-term rates inched up, monthly year-on-year inflation has reached
historically low levels, which bodes well for the long-term decline in interest
rates. Bank Slaski, one of the Fund's largest Polish holdings, is well
positioned to benefit from rapidly growing individual and corporate loan demand,
while maintaining a strong retail deposit base. In addition, the rise in credit
growth is a clear indication of rising purchasing power in the Polish
population. The Fund recently invested in the white goods producer Best which
offers exposure to the growing demand for consumer goods. Several other
companies in the portfolio are plays on increased consumption of a variety of
goods, from food stuffs to computers. A wave of capital increases and IPOs has
also worried the market. More than $1 billion of equity capital is going to be
raised during 1997, raising concerns of an oversupply of stock. While it is
imperative to be extremely selective of new offerings in the current market
environment, the Fund has participated in the most attractive offerings and will
continue to be active in the future.
The Hungarian market was Central Europe's strongest performer for the quarter
and the allocation to the country approached 8% of the Fund's net assets. The
majority of Hungarian companies continue to display excellent earnings
performance stemming from restructuring efforts undertaken during the last few
years. Shortly after inception in September 1996, the Fund took a significant
position in the market's largest stock, MOL, the integrated oil and gas
monopoly. After a rise of more than 50% during the quarter, the Fund took
profits ahead of a large supply in the stock from the further sale of the
government's stake. The Hungarian market is still small, with a market cap of
only around $5 billion and trading volumes are thin. Yet, continued strong
earnings performance, which would be boosted by strong economic growth in
Germany (the country's main trading partner), should lead to outperformance.
The Czech market continues to be underweight in the portfolio due to the rich
valuations and the general lack of market transparency. For the first quarter,
the market actually fell 1.7% in dollar terms. Towards the end of 1996 the
government mandated that all off-exchange transactions be made public and
announced the creation of a U.S.-style securities commission. It appeared that
the negative sentiment surrounding the market was overdone and the Fund took
small positions in both companies with the highest growth prospects and
selective locally listed funds that traded at large discounts to net asset
value. Sentiment towards the market slightly improved, discounts narrowed and
funds have out-performed the market as a whole. But the slow rate of change in
the market, combined with a growing current account deficit and a rapid decline
in the rate of economic growth, points to a continued underweight of the Czech
market.
Over the longer term, the Fund's investment region still has exceptional
potential, but in the immediate future progress in some of the main markets,
particularly in the larger stocks, will be limited. In order to maximize
shareholder return, the Fund will, therefore, seek to take advantage of its size
and regional mandate to make the most of the niche opportunities within the
target markets.
Sincerely,
[SIGNATURE]
Warren J. Olsen
PRESIDENT AND DIRECTOR
[SIGNATURE]
Madhav Dhar
PORTFOLIO MANAGER
[SIGNATURE]
Marianne L. Hay
PORTFOLIO MANAGER
[SIGNATURE]
Michael Hewett
PORTFOLIO MANAGER
April 1997
3
<PAGE>
Morgan Stanley Russia & New Europe Fund, Inc.
Investment Summary as of March 31, 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 32.64% 30.72% 29.95%
SINCE INCEPTION* 19.75 36.17 42.20
</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
PERIOD ENDED
DECEMBER 31, THREE MONTHS ENDED
1996* MARCH 31,1997
<S> <C> <C>
Net Asset Value Per Share $ 20.77 $ 27.15
Market Value Per Share $18.00 $23.88
Premium/(Discount) -13.3% -12.0%
Income Dividends $0.07 -
Capital Gains Distributions -- -
Fund Total Return (2) 4.18% 30.72%
Index Total Return (3) 9.43% 29.95%
Morgan Stanley Russia and New Europe Fund, Inc. (2)
Russia and New Europe Blended Composite (3)
</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.
4
<PAGE>
Morgan Stanley Russia & New Europe Fund, Inc.
Portfolio Summary as of March 31, 1997 (Unaudited)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PORTFOLIO INVESTMENTS DIVERSIFICATION
[EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC]
<TABLE>
<S> <C>
Debt Instruments 9.6%
Equity Securities 86.4%
Short-Term Investment 4.0%
</TABLE>
- --------------------------------------------------------------------------------
SECTORS
[EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC]
<TABLE>
<S> <C>
Banking 4.0%
Construction & Housing 1.9%
Data Processing & Reproduction 2.8%
Energy Sources 20.1%
Financial Services 4.0%
Foreign Government Bonds 8.8%
Health & Personal Care 2.9%
Retail 3.5%
Telecommunications 6.7%
Utilities-Electrical & Gas 19.1%
Other 26.2%
</TABLE>
- --------------------------------------------------------------------------------
COUNTRY WEIGHTINGS
[EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC]
<TABLE>
<S> <C>
Russia 59.1%
Poland 16.1%
Hungary 6.6%
Croatia 3.2%
Czech Republic 2.6%
Slovakia 0.8%
Other 11.6%
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS*
PERCENT OF
NET ASSETS
----------
<C> <S> <C>
1. Unified Energy System 9.4%
2. Republic of Russia Debt 8.8
3. Lukoil Holdings 7.1
4. Moscow Energy 5.5
5. Rostelecom 4.9
<CAPTION>
PERCENT OF
NET ASSETS
----------
<C> <S> <C>
6. Surgutneftegaz ADR 4.8%
7. Noyabrskneftegaz 2.6
8. Computerland Poland 2.3
9. National Investment Fund GDR 2.2
10. Zagrebacka Banka GDR 2.1
-----
49.7%
-----
-----
</TABLE>
* Excludes short-term investments.
5
<PAGE>
INVESTMENTS (UNAUDITED)
- ---------
MARCH 31, 1997
<TABLE>
<CAPTION>
VALUE
SHARES (000)
<S> <C> <C>
- ---------------------------------------------------------
- ------------
COMMON STOCKS (79.6%)
(Unless otherwise noted)
- --------------------------------------------------
- ----------
CZECH REPUBLIC (2.6%)
FINANCIAL SERVICES
PF IKS KB 150,000 U.S.$ 932
Resolution Investment Fund 26,100 917
Zivnobanka -- Investicni Fond 40,404 652
--------------
2,501
--------------
MACHINERY & ENGINEERING
CKD Praha Holding 12,656 382
Skoda Plzen 20,500 671
--------------
1,053
--------------
3,554
--------------
- ---------------------------------------------------------
- ------------
CROATIA (3.2%)
BANKING
Zagrebacka Banka GDR 90,500 2,862
--------------
HEALTH & PERSONAL CARE
Pliva d.d. GDR 104,500 1,513
--------------
4,375
--------------
- ---------------------------------------------------------
- ------------
HUNGARY (6.6%)
AUTOMOBILES
Mezogep 90,000 964
--------------
BUILDING MATERIALS & COMPONENTS
Zalakeramia Rt. 25,000 1,194
--------------
CHEMICALS
BorsodChem Rt. GDR 34,000 1,249
--------------
ENERGY SOURCES
Primagaz Rt. 16,000 993
--------------
HEALTH & PERSONAL CARE
Richter Gedeon Rt. GDR 39,300 2,427
--------------
MISCELLANEOUS MATERIALS & COMMODITIES
Pannonplast Rt. 47,325 2,102
--------------
8,929
--------------
- ---------------------------------------------------------
- ------------
POLAND (16.1%)
AUTOMOBILES
Sanockie Zaklady Przemyslu Gumowego
Stomil 51,986 1,116
--------------
BANKING
Bank Slaski 13,800 1,302
BIG 975,000 1,268
--------------
2,570
--------------
BUILDING MATERIALS & COMPONENTS
Budimex 165,000 1,503
--------------
</TABLE>
- ---------------------------------------------------------
- ------------
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- ---------------------------------------------------------
- ------------
<S> <C> <C>
CONSTRUCTION & HOUSING
Polifarb Cieszyn 222,000 U.S.$ 1,444
Polifarb Wroclaw 215,000 1,133
--------------
2,577
--------------
DATA PROCESSING & REPRODUCTION
Computerland Poland 100,900 3,183
OPTIMUS 'D' 16,866 636
--------------
3,819
--------------
ENERGY EQUIPMENT & SERVICES
Elektrobudowa 60,000 1,220
--------------
FINANCIAL SERVICES
National Investment Fund GDR 50,000 2,950
--------------
FOOD & HOUSEHOLD PRODUCTS
Farm Food 20,000 358
Farm Food -- New 92,450 1,654
Sokolowskie Zaklady Miesne 195,678 376
--------------
2,388
--------------
MULTI-INDUSTRY
Elektrim Spolka Akcyjna 201,000 1,765
--------------
RETAIL
Best 107,000 2,019
--------------
21,927
--------------
- ---------------------------------------------------------
- ------------
RUSSIA (50.3%)
BROADCASTING & PUBLISHING
Storyfirst Communications
(Convertible) 1,632 1,938
--------------
ENERGY SOURCES
Lukoil Holdings 500,000 7,080
Lukoil Holdings (Preferred) 230,000 2,518
Megionneftegas 150,000 855
Noyabrskneftegaz 270,000 3,510
Orenburgneft 60,000 354
Purneftegaz 485,000 2,449
Surgutneftegaz ADR 175,000 6,519
Tatneft ADR 41,200 2,822
Urdmurtneft 3,500 189
--------------
26,296
--------------
RETAIL
Trade House TSUM 4,000,000 2,700
--------------
METALS -- NON-FERROUS
Norilsk Nickel 166,000 984
Norilsk Nickel (Preferred) 100,000 410
--------------
1,394
--------------
METALS -- STEEL
Seversky Tube Works 200,000 580
Seversky Tube Works ADR 10,000 290
--------------
870
--------------
</TABLE>
- ---------------------------------------------------------
- ------------
6
<PAGE>
<TABLE>
<CAPTION>
VALUE
SHARES (000)
- ---------------------------------------------------------
- ------------
<S> <C> <C>
RUSSIA (CONTINUED)
TELECOMMUNICATIONS
Nizhny Novgorod Telephone 200,000 U.S.$ 670
Rostelecom 1,722,400 6,717
St. Petersburg Telephone Network 1,100,000 1,760
--------------
9,147
--------------
UTILITIES
Gazprom ADR 125,000 2,028
Irkutskenergo 4,000,000 1,028
Lenenergo 3,000,000 2,595
Moscow Energy 5,750,000 7,532
Unified Energy System (UES) 66,800,000 12,806
--------------
25,989
--------------
68,334
--------------
- ---------------------------------------------------------
- ------------
SLOVAKIA (0.8%)
CHEMICALS
Slovnaft 35,000 1,074
--------------
- ---------------------------------------------------------
- ------------
TOTAL COMMON STOCKS
(Cost U.S. $79,717) 108,193
--------------
- ---------------------------------------------------------
- ------------
<CAPTION>
FACE
AMOUNT
(000)
<S> <C> <C>
- ---------------------------------------------------------
- ------------
DEBT INSTRUMENTS (8.8%)
- ---------------------------------------------------------
- ------------
RUSSIA (8.8%)
BONDS (5.9%)
Ministry of Finance
Tranche IV 3.00%, 5/14/03 U.S.$ 6,000 3,682
Ministry of Finance
Tranche VI GDR 3.00%, 5/14/06 9,000 4,359
--------------
8,041
--------------
LOAN AGREEMENT (2.9%)
Bank for Foreign Economic Affairs
(Participation: Chase Securities,
Inc.) 5,000 3,913
- ---------------------------------------------------------
- ------------
TOTAL DEBT INSTRUMENTS
(Cost U.S. $12,097) 11,954
--------------
- ---------------------------------------------------------
- ------------
<CAPTION>
FACE
AMOUNT VALUE
(000) (000)
<S> <C> <C>
- ---------------------------------------------------------
- ------------
SHORT-TERM INVESTMENT (3.7%)
- ---------------------------------------------------------
- ------------
UNITED STATES (3.7%)
REPURCHASE AGREEMENT
Chase Securities, Inc. 6.00%, dated
3/31/97, due 4/1/97, to be
repurchased at U.S. $5,065,
collateralized by United States
Treasury Notes, 7.875%, due
11/15/04, valued at U.S. $5,159.
(Cost U.S. $5,064) U.S.$ 5,064 U.S.$ 5,064
--------------
- ---------------------------------------------------------
- ------------
TOTAL INVESTMENTS (92.1%)
(Cost U.S. $96,878) 125,211
--------------
- ---------------------------------------------------------
- ------------
OTHER ASSETS AND LIABILITIES (7.9%)
Other Assets 18,666
Liabilities (8,014) 10,652
--------------- --------------
- ---------------------------------------------------------
- ------------
NET ASSETS (100%)
Applicable to 5,005,000 issued and
outstanding U.S. $0.01 par value
shares (100,000,000 shares
authorized) U.S.$ 135,863
--------------
--------------
- ---------------------------------------------------------
- ------------
NET ASSET VALUE PER SHARE U.S.$ 27.15
--------------
--------------
- ---------------------------------------------------------
- ------------
</TABLE>
ADR -- American Depositary Receipt
GDR -- Global Depositary Receipt
7
