Rio Tinto shares rallied after Federal Treasurer Wayne Swan cleared the way for a Chinese state-owned aluminium maker's bid to increase its stake in the company.

Mr Swan approved Chinalco's stake of about 9.3 per cent of dual-listed Rio Tinto to 11 per cent, which could influence the outcome of BHP Billiton's proposed $175billion hostile takeover of Rio.

Rio's shares in Sydney rose as much as 3 per cent but lost most of those gains during the day to close 1.1 per cent, or $1.30, higher, at $120.30. Shares in BHP Billiton dropped 0.45 per cent, or 15c, to $40.

Chinalco, in partnership with the American mining group Alcoa, spent $14.9billion to become Rio Tinto's largest shareholder in February.

The acquisition of 12 per cent of Rio Tinto's London shares was the biggest single foreign investment made by a Chinese company to date and had to overcome serious political concerns in Australia. Mr Swan said in a statement released on Sunday he would allow the Chinese company to buy as much as 14.99 per cent of Rio Tinto's London shares.

Rio Tinto has a dual listing in Sydney and a 14.99 per cent stake in London would equate to about 11 per cent in the entire group.

But Mr Swan set two conditions: that Chinalco does not raise its stake above that level without fresh approval from the Australian Government and that it will not seek to appoint a director to the Rio Tinto board as long as its stake remains below 15 per cent.

It is debatable whether Chinalco will feel bound by the conditions. Chinalco president Xiao Yaqing suggested in June the company did not need Australia's approval because it had bought the shares in London. Chinalco's swoop on Rio Tinto was widely regarded as a bid to block BHP rather than a precursor to its own takeover bid. with agencies