Because dispatch.py cares about --encoding the web:encoding encoding has to be
set before. Either dispatch.py is (heavily) modified so the --encoding is set
later or dispatch.py does somehow know that "hg serve" has not default behavior.

if cmd == "serve":
  if foo.config("web", "encoding"):
    util._encoding = foo.config("web", "encoding")
if options["encoding"]:
  util._encoding = options["encoding"]

But hey guys i think you know 100 times better than me where a fix would be
appropriate. Or do you play snakes and ladders with me - ding ding - wrong path,
go back to start and try once more :)