T. Rowe Price Institutional Africa & Middle East Fund

N-CSR 1 ariam.htm T. ROWE PRICE INSTITUTIONAL AFRICA & MIDDLE EAST FUND T. Rowe Price Institutional Africa & Middle East Fund - October 31, 2008

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT OF REGISTERED

MANAGEMENT INVESTMENT COMPANIES

Investment Company Act File Number: 811-5833

T. Rowe Price Institutional International Funds, Inc.

(Exact name of registrant as specified in charter)

100 East Pratt Street, Baltimore, MD 21202

(Address of principal executive offices)

David Oestreicher

100 East Pratt Street, Baltimore, MD 21202

(Name and address of agent for service)

Registrant’s telephone number, including area code: (410) 345-2000

Date of fiscal year end: October 31

Date of reporting period: October 31, 2008

Item 1: Report to Shareholders

Institutional Africa & Middle East Fund

October 31, 2008

The views and opinions in this report were current as of October 31, 2008. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the fund’s future investment intent. The report is certified under the Sarbanes-Oxley Act, which requires mutual funds and other public companies to affirm that, to the best of their knowledge, the information in their financial reports is fairly and accurately stated in all material respects.

Manager’s Letter
T. Rowe Price Institutional Africa & Middle East Fund

Dear Investor

This is our first report for the T. Rowe Price Institutional Africa & Middle East Fund, and we would like to welcome all shareholders. Emerging market stocks plunged as investors fled riskier assets in the six-month period ended October 31, 2008. Equities in Africa and the Middle East held up somewhat better than shares in other developing regions, but our target markets were not immune to the global financial crisis, and returns to investors were sharply negative. Declines in Middle Eastern markets were exacerbated by the departure of speculative short-term investments following the steep drop in oil prices and the realization that countries in the region would not revalue their currencies versus the U.S. dollar.

We are disappointed to report that your fund returned -50.50% in the first six months of operations. As shown in the Performance Comparison table, the fund underperformed its benchmark. We exclude Saudi Arabia because its market is not yet open to overseas investors and Israel because the country’s economy shares more of the characteristics of a developed market than an emerging market.

Results in the last six months reflect poor performance of our holdings in Egypt, whose market fell 58% in part because of rising inflation; in South Africa, where our platinum companies plunged with the price of the commodity; and in Oman and the United Arab Emirates (UAE), where markets dropped about 50% amid profit taking and concerns about a property price bubble, respectively.

Highlights

• Equities in Africa and the Middle East plunged as the global financial crisis deepened in the six-month period ended October 31, 2008.

• Your fund underperformed its benchmark index since the fund’s inception on April 30, 2008.

• Although financial companies were among the largest performance detractors in the last six months, we still believe that the fundamentals for Middle East commercial banks are strong.

• Despite the brutal global stock market sell-off in recent months, economies in our target regions are strong, and many countries have amassed vast reserves during years of high commodity and oil prices.

We, like you, are shocked by the depth of the downturn and the speed at which the market environment deteriorated in the last few months. We know your investment is very important to you, and we will continue to search on your behalf for the best long-term investment opportunities in our target regions.

WHY INVEST IN AFRICA AND THE MIDDLE EAST?

Although we cannot be sure how long the global financial crisis will weigh on the markets, we continue to believe that these regions offer excellent long-term prospects. We would like to briefly review the case for investing in African and Middle Eastern markets.

Africa

• Excluding South Africa, growth in the sub-Saharan part of the continent has been strong for much of this decade, a marked turnaround from the 1980–1999 period when the region’s expansion lagged the rest of the world.

• The boom in commodity prices in the last few years has improved the terms of trade for many African countries that export oil, precious metals, bulk commodities, and agricultural produce. In addition, China has actively pursued bilateral agreements to secure supplies for its resource-hungry economy, and it is likely to remain a long-term trade partner.

• Many African countries have been able to reduce their debt obligations, thanks in part to favorable cancellation terms offered by creditor nations in the West and by global institutions. This has enabled them to accumulate exchange reserves that help promote currency stability and, in some cases, currency appreciation.

• Many African nations are implementing economic policies that emphasize fiscal restraint and help lower inflation, while the spread of democracy has helped to build political, social, and economic accountability. All of these developments have stimulated investment.

A Word From Our Chairman

Dear Shareholder,

The past year has seen a substantial and painful decline in the broad stock and bond markets, both domestically and internationally, and our funds have not been immune to the turmoil. Being an investor in these times can be unsettling because there seem to be few safe havens. Prudent risk-management strategies, such as diversification, may have helped to reduce losses, but they did not avoid them.

At times like these, taking a step back to gain perspective can help. Since Thomas Rowe Price, Jr., founded our company in 1937—in the heart of the Great Depression—the firm has witnessed many market downturns, including the long, slow 1973–1974 bear market, the October 1987 crash, and the bursting of the technology bubble in the early 2000s and the subsequent broad market decline. Although the magnitude and duration of the declines have varied, one thing has held true: The markets have always bounced back.

We also know from experience that emotional responses to financial downturns do not produce good results. Now is the time for investors to remain focused on the fundamentals and to maintain a long-term perspective. That’s what we are doing at T. Rowe Price. Our experienced team of analysts and portfolio managers continually examines our portfolios to make sure each fund’s holdings still make sense in the ever-changing environment. And as painful as market downturns are, the indiscriminate selling that accompanies a panic creates opportunities for investors who can see beyond the fear. We are using our rigorous in-house research to position our portfolios for the next upturn.

As always, we remain focused on serving our shareholders. Managing our clients’ assets is our only business, and our long-term success is tied to our clients’ success. We know this period has been difficult for investors, and we thank you for your confidence in T. Rowe Price.

Sincerely,

Edward C. Bernard
Chairman, T. Rowe Price Mutual Funds

Middle East

• Since prices bottomed in the late 1990s, increased revenues from oil have fueled the economic growth of countries in the Gulf Cooperation Council (GCC): Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE.

• GCC countries have robust economic fundamentals and substantial current account surpluses that we believe are likely to continue expanding, unless the recent decline in oil prices is sustained.

• Although the region has had oil-driven booms in the 1970s and 1980s, what’s different this time is that GCC countries are opening their economies in an attempt to decrease their dependence on crude oil. Specifically, governments are trying to increase non-oil revenues through government-led investment.

• After years of underinvestment in areas such as housing, numerous infrastructure projects in the region are under way. Qatar, for example, has several high-profile projects related to infrastructure, financial services, and tourism. Such projects are encouraging improvements in the political and legislative climate of other GCC countries.

Despite the brutal global stock market sell-off in recent months, economies in our target regions are strong, and many countries have amassed vast reserves during years of high commodity and oil prices. Slower global growth and the recent drop in commodity prices will have an impact on Africa and the Middle East, but regional growth is likely to be underpinned by government spending on infrastructure and investments in many sectors.

PORTFOLIO REVIEW

Middle East
The five GCC countries in which we currently invest—Qatar, the UAE, Oman, Kuwait, and Bahrain—accounted for more than 50% of the fund’s assets at the end of October. Egypt, Jordan, and Lebanon represented more than 16% of assets.

Many of our holdings in the Middle East are financial companies, which were among the largest performance detractors in the last six months. Some companies, such as Dubai Financial Markets, tumbled due to their exposure to the capital markets. Property stocks, such as Emaar Properties and Aldar Properties in the UAE, plunged amid concerns that a speculative property bubble could burst as investors are forced to deleverage their investments. In addition, commercial banks such as National Bank of Oman and Commercial Bank of Qatar were hit by the global credit crisis and concerns about slowing growth. We like commercial banks because lenders often are among the first beneficiaries of an expanding emerging economy, experiencing significant revenue growth as demand for both retail and business credit increases. (Please refer to the fund’s portfolio of investments for a complete listing of holdings and the amount each represents in the portfolio.)

Although liquidity among financial companies has become an issue in some parts of the region, especially Dubai, we continue to believe that the fundamentals for Middle East banks are strong. They are well capitalized, have little or no exposure to “structured” investments such as the ones that have disrupted the U.S. credit market, and should continue to benefit from loan growth, albeit at a slower pace.

Poor performance of companies involved in regional infrastructure development also detracted significantly from our results in the last six months. Construction and engineering companies Orascom Construction (based in Egypt) and Galfar Engineering & Contracting (based in Oman) were among the worst performers in the entire portfolio, hammered by concerns about slower economic growth. Omani companies Raysut Cement and Oman Cement tumbled for the same reason. Despite the global economic downturn and the possibility of financing issues in the near term, we believe that regional infrastructure development will remain a long-term trend. Many infrastructure projects in the Middle East were initiated when oil prices were well below today’s levels and thus are unlikely to be derailed by reduced oil revenues.

Africa
South African stocks plunged nearly 43% in the last six months. The market was hampered by double-digit inflation and interest rates, a weakening currency, and reliance on external financing to fund a growing trade deficit. Although our weighting in the country was fairly small (about 7% of assets at the end of October), our exposure to platinum mining companies—Aquarius Platinum, Impala Platinum Holdings, and Northam Platinum—contributed to the fund’s poor performance. Demand for platinum, which is used in catalytic converters, fell sharply as global demand for automobiles declined. Production delays and labor strikes have contributed to the mining companies’ woes. We eliminated Northam but maintained our investments in Impala and Aquarius, as we believe they will fare better in this challenging environment than their competitors.

In sub-Saharan Africa, we own only one other stock—Nigerian bank Guaranty Trust Bank. As markets open and new investment opportunities become available, we will look to add to our African exposure.

OUTLOOK

Investors in emerging markets often have had to brace for a wild ride, but the most recent six-month period has been especially painful, and we, like you, are disappointed with the poor performance of the markets and the fund. But despite the sharp stock market and commodity price declines and signs of liquidity constraints in certain parts of our target regions, we continue to believe in the long-term prospects for Africa and the Middle East.

We expect GDP growth to remain strong, and while earnings growth will slow from the heady pace seen over the last year, growth should remain very attractive in a global context. Valuations are at a slight premium to emerging markets as a whole, but they have fallen significantly and are very attractive. Nevertheless, markets in our target regions are nascent, and periods of high volatility should be expected.

Although the markets and economies in our target regions seemed to be moving in lockstep in the last few years, we are beginning to see signs of differentiation. For example, the economies of Qatar and Oman remain strong, whereas parts of the UAE are showing signs of weakening due to a speculative property market bubble and reliance on external debt funding to support its growth. We will closely monitor this trend and look to take advantage of attractively valued long-term investment opportunities.

The fund remains highly concentrated in the Middle East and has more than 40% of its assets invested in the financials sector. As markets develop and deepen and new opportunities appear, we will seek to diversify the portfolio into African countries and other market sectors over time. We are actively researching new and interesting candidates for investment.

Once again, we would like to welcome all shareholders to the fund, and we thank you for your confidence in our investment management abilities, particularly during this extraordinarily difficult period for the financial markets. In closing, we would like to remind you that, due to the risks and volatility inherent in emerging market stocks, particularly in Africa and the Middle East, this fund is for long-term investors and should represent only a small portion of a well-diversified portfolio.

Respectfully submitted,

Christopher D. Alderson
Portfolio Manager

November 18, 2008

The portfolio manager has day-to-day responsibility for managing the portfolio and works with committee members in developing and executing the fund’s investment program.

Portfolio Manager Change

As you may know, Chris Alderson will succeed David Warren as president of T. Rowe Price International at the end of March 2009 and Joseph Rohm will succeed Mr. Alderson as chairman of the Institutional Africa & Middle East Fund’s Investment Advisory Committee, effective March 31, 2009. Mr. Rohm has eight years of investment experience, three of which are with T. Rowe Price, and he currently serves on the fund’s Investment Advisory Committee. Since mid-2007, Mr. Rohm’s research has been entirely focused on Africa and the Middle East. He has worked closely with Mr. Alderson on these markets and has traveled extensively throughout the region. Mr. Alderson will remain on the fund’s Investment Advisory Committee.

Risks of International Investing

Funds that invest overseas generally carry more risk than funds that invest strictly in U.S. assets. Funds investing in a single country, limited geographic region, or emerging market tend to be riskier than more diversified funds. Risks can result from varying stages of economic and political development; differing regulatory environments, trading days, and accounting standards; and higher transaction costs of non-U.S. markets. Non-U.S. investments are also subject to currency risk, or a decline in the value of a foreign currency versus the U.S. dollar, which reduces the dollar value of securities denominated in that currency.

Glossary

S&P/IFCG Middle East & Africa Index: An index created by Standard & Poor’s that measures the performance of the most active stocks in emerging Middle Eastern and African markets. S&P uses data from the International Finance Corporation to create this capitalization-weighted index.

Portfolio Highlights

Performance and Expenses
T. Rowe Price Institutional Africa & Middle East Fund

Fund Expense Example

As a mutual fund shareholder, you may incur two types of costs: (1) transaction costs, such as redemption fees or sales loads, and (2) ongoing costs, including management fees, distribution and service (12b-1) fees, and other fund expenses. The following example is intended to help you understand your ongoing costs (in dollars) of investing in the fund and to compare these costs with the ongoing costs of investing in other mutual funds. The example is based on an investment of $1,000 invested at the beginning of the most recent six-month period and held for the entire period.

Actual Expenses
The first line of the following table (“Actual”) provides information about actual account values and actual expenses. You may use the information in this line, together with your account balance, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading “Expenses Paid During Period” to estimate the expenses you paid on your account during this period.

Hypothetical Example for Comparison Purposes
The information on the second line of the table (“Hypothetical”) is based on hypothetical account values and expenses derived from the fund’s actual expense ratio and an assumed 5% per year rate of return before expenses (not the fund’s actual return). You may compare the ongoing costs of investing in the fund with other funds by contrasting this 5% hypothetical example and the 5% hypothetical examples that appear in the shareholder reports of the other funds. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period.

You should also be aware that the expenses shown in the table highlight only your ongoing costs and do not reflect any transaction costs, such as redemption fees or sales loads. Therefore, the second line of the table is useful in comparing ongoing costs only and will not help you determine the relative total costs of owning different funds. To the extent a fund charges transaction costs, however, the total cost of owning that fund is higher.