diff --git a/mercurial/merge.py b/mercurial/merge.py
--- a/mercurial/merge.py
+++ b/mercurial/merge.py
@@ -812,6 +812,13 @@
 
     diff = m1.diff(m2, match=matcher)
 
+    # we might miss adding an action for the rename destination file as it
+    # didn't change between m2 and ma and hence was optimized out. However,
+    # the file is important as it contains rename information which is
+    # important. Stores such actions and makes sure they are all there
+    # in mresult object. If not, adds them.
+    rename_dest_actions = {}
+
     for f, ((n1, fl1), (n2, fl2)) in pycompat.iteritems(diff):
         if n1 and n2:  # file exists on both local and remote side
             if f not in ma:
@@ -933,12 +940,41 @@
                         f, mergestatemod.ACTION_REMOVE, None, b'other deleted',
                     )
             else:  # file not in ancestor, not in remote
-                mresult.addfile(
-                    f,
-                    mergestatemod.ACTION_KEEP,
-                    None,
-                    b'ancestor missing, remote missing',
-                )
+                rename_found = False
+                for source, dest in branch_copies1.dirmove.items():
+                    if f.startswith(dest):
+                        # this directory in which this file is created
+                        # is moved from somewhere else
+                        # we should check if the source file exists on
+                        # remote side
+                        sf = source + f[len(dest) :]
+                        if sf in m2:
+                            rename_found = True
+                            if m2[sf] == ma[sf]:
+                                mresult.addfile(
+                                    f,
+                                    mergestatemod.ACTION_KEEP,
+                                    None,
+                                    b'file is rename dest and rename source'
+                                    b' did not change',
+                                )
+                            else:
+                                mresult.addfile(
+                                    f,
+                                    mergestatemod.ACTION_MERGE,
+                                    (f, sf, sf, False, pa.node()),
+                                    b'local directory rename - respect move '
+                                    b'from %s' % sf,
+                                )
+                            break
+
+                if not rename_found:
+                    mresult.addfile(
+                        f,
+                        mergestatemod.ACTION_KEEP,
+                        None,
+                        b'ancestor missing, remote missing',
+                    )
 
         elif n2:  # file exists only on remote side
             if f in copied1:
@@ -1010,8 +1046,19 @@
                         df = branch_copies1.dirmove[d] + f[len(d) :]
                         break
                 if df is not None and df in m1:
+                    # this file is not present in local however its a source
+                    # of rename for another file. keep this file not
+                    # present in local.
                     mresult.addfile(
-                        df,
+                        f,
+                        mergestatemod.ACTION_KEEP_ABSENT,
+                        None,
+                        b'remote directory is rename source - respect move '
+                        b'to %s' % df,
+                    )
+                    # action for rename destination is important and can be
+                    # missed due to some optimizations.
+                    rename_dest_actions[df] = (
                         mergestatemod.ACTION_MERGE,
                         (df, f, f, False, pa.node()),
                         b'local directory rename - respect move '
@@ -1039,6 +1086,12 @@
                     b'local not present, remote unchanged',
                 )
 
+    # make sure actions for rename destination are there and if not
+    # add them
+    for f, data in pycompat.iteritems(rename_dest_actions):
+        if mresult.getfile(f) is None:
+            mresult.addfile(f, *data)
+
     if repo.ui.configbool(b'experimental', b'merge.checkpathconflicts'):
         # If we are merging, look for path conflicts.
         checkpathconflicts(repo, wctx, p2, mresult)