SYDNEY - Northern Minerals on Tuesday said Australia's government has blocked the heavy rare earths producer's largest shareholder, China's Yuxiao Fund, from increasing its investment on the grounds of national interest.

Yuxiao Fund sought Foreign Investment Review Board approval in August to raise its ownership to 19.9% from 9.92%. A government register showed Treasurer Jim Chalmers signed a prevention order on February 15.

Industry sources told Reuters it was the first decision to block a Chinese investment since Chalmers said in a November speech the Ukraine war had elevated concern among Western nations about the highly concentrated critical minerals' supply chain, which is dominated by China.

Chalmers said Australia, the world's top lithium supplier and a major producer of rare earths, would become more selective about who it lets invest in its critical minerals industry.

The Singapore-registered Yuxiao Fund is an investment vehicle of Chinese national Yuxiao Wu, who also owns miners in Mozambique supplying lower-grade rare earths to China, Northern Minerals executive chairman Nick Curtis told Reuters.

"There is a special category of assets for any government to protect its national interest," Curtis said.

Singapore business registry filings for Yuxiao Fund show Wu is the sole shareholder and a Chinese citizen. He could not be reached for comment.

The Australian Treasurer's office, which would be responsible for blocking such an investment based on the advice of the review board, declined to comment.

China has criticised Australia for previously blocking Chinese investment on national security grounds, saying this contributed to a years-long diplomatic freeze.

Relations between the two countries are improving after years of strained ties, with Chinese "trade blockages" on some Australian exports starting to ease.

Australian mining industry sources said the latest decision could have consequences for Chinese investment in other less sensitive sectors, if China saw it as a hardening of Australian attitudes.

Australian Strategic Policy Institute executive director Justin Bassi, a former national security adviser, wrote on Twitter that the decision showed the government's effort to stabilise its relationship with China "doesn't mean avoiding tough decisions".

When asked about another prospective Chinese investment in lithium, Prime Minister Anthony Albanese said last week his government would consider the merits of any deal but favoured using rare earths and other critical minerals to make batteries in Australia.

Northern Minerals said it planned to become the first significant world producer of dysprosium outside China, which controls 94% of supply. Dysprosium is a key component for magnets for electric vehicles.

"Our material is needed for the magnet supply chain," said Curtis, adding this was the likely reason the increased investment by a Chinese investor was blocked.

Northern Minerals second-largest shareholder is also Chinese, although Chinese citizens or high net worth Australian citizens of Chinese background hold less than 30% of shares, he said.

Wu invested in Northern Minerals for financial reasons, not to supply China, and voted in favour of an exclusive supply deal with Australia's Iluka Resources last year, Curtis said.