Rio Tinto dismisses 'harebrained' Fortescue iron ore plan

* Rio CEO says no benefit to Australia in Fortescue plan

* Says Rio does not collude on iron ore production (Recasts lead, adds analyst comment)

By Sonali Paul

MELBOURNE, March 26 (Reuters) - The head of the world's second-largest iron ore miner dismissed as "harebrained" a suggestion by smaller rival Fortescue Metals Group that miners should cap output of the steelmaking raw material to boost prices.

Rio Tinto Chief Executive Sam Walsh said on Thursday there would be no benefit to Australia from trying to support the iron ore price by setting a cap on production, despite market oversupply and waning demand growth in China.

"To try and artifically prop it up with some harebrained scheme, that's just physically not going to work," Walsh told a mining conference.

Rio Tinto (Xetra: 855018 - news) , which sits behind only Brazil's Vale in iron ore output, is set to increase its production to 320 million tonnes this year, while BHP Billiton (NYSE: BBL - news) is targeting 245 million tonnes, both well above Fortescue's 155 million tonne target.

Walsh was speaking two days after Fortescue Chairman Andrew Forrest called on larger iron ore miners to join Fortescue in limiting production, prompting Australia's competition regulator to investigate whether he breached the law by calling for a cartel.

"There have been a number of comments about whether Rio colludes with others. Let me assure you, we absolutely do not," Walsh said, describing Forrest's remarks as "absolute nonsense".

Forrest argued that just as Fortescue, Rio Tinto and BHP Billiton have invested billions of dollars expanding in a rising market, they should cap production now that prices are falling.

Analysts said his comments were a sign of how tough the market had become for everyone in the iron ore industry, with prices having halved over the past year to stand at $55.50 , close to Fortescue's break-even price.

"They're all criticising each other because they're all under pressure and under stress and they're looking around for somebody to blame. But this outcome was designed by them collectively, not by any one of them individually," said Brenton Saunders, an analyst at BT Investment Management.

Lower-cost miners Rio Tinto and BHP are both still expanding output, while Fortescue's production is mostly stagnant at an annualised rate of about 160 million tonnes, after it completed a massive expansion over the past two years.

BHP and Rio both say that any draw back on their part would be replaced by other mining companies, doing little to address overall supply.

Rio Tinto closed modestly lower in Australian trade at A$56.50, while Fortescue rose 3.9 percent to A$2.12 in a weaker overall market. (Additional reporting by James Regan in SYDNEY; Editing by Richard Pullin)