diff --git a/setup.py b/setup.py
--- a/setup.py
+++ b/setup.py
@@ -97,7 +97,10 @@ try:
 except ImportError:
     pass
 
-try:
+def getversion():
+    if not os.path.exists('.hg'):
+        return None # not in a repository
+
     # execute hg out of this directory with a custom environment which
     # includes the pure Python modules in mercurial/pure
     pypath = os.environ.get('PYTHONPATH', '')
@@ -105,23 +108,31 @@ try:
     os.environ['PYTHONPATH'] = os.pathsep.join(['mercurial', purepath, pypath])
     os.environ['HGRCPATH'] = '' # do not read any config file
     cmd = '%s hg id -it' % sys.executable
-    l = os.popen(cmd).read().split()
+
+    try:
+        l = os.popen(cmd).read().split()
+    except OSError, e:
+        print "warning: could not establish Mercurial version: %s" % e
+
     os.environ['PYTHONPATH'] = pypath
+
     while len(l) > 1 and l[-1][0].isalpha(): # remove non-numbered tags
         l.pop()
-    version = l and l[-1] or 'unknown' # latest tag or revision number
-    if version.endswith('+'):
-        version += time.strftime('%Y%m%d')
+    if l:
+        version = l[-1] # latest tag or revision number
+        if version.endswith('+'):
+            version += time.strftime('%Y%m%d')
+        return version
 
-except OSError, e:
-    print "warning: could not establish Mercurial version: %s" % e
+version = getversion()
+if version:
+    f = file("mercurial/__version__.py", "w")
+    f.write('# this file is autogenerated by setup.py\n')
+    f.write('version = "%s"\n' % version)
+    f.close()
+else:
     version = "unknown"
 
-f = file("mercurial/__version__.py", "w")
-f.write('# this file is autogenerated by setup.py\n')
-f.write('version = "%s"\n' % version)
-f.close()
-
 class install_package_data(install_data):
     def finalize_options(self):
         self.set_undefined_options('install',