man 5 hgrc implied you need to use external tools to do CRLF translation.
This is no longer true; win32text provides a much better in-process alternative.
#!/bin/sh
hg init
echo "nothing" > a
hg add a
hg commit -m ancestor -d "1000000 0"
echo "something" > a
hg commit -m branch1 -d "1000000 0"
hg co 0
echo "something else" > a
hg commit -m branch2 -d "1000000 0"
hg merge 1
hg id
cat a
hg status