Hmm i managed to get it working.

I started the emulator manually from command line and passed it partition
size of 1024 instead of 512.  For whatever reason this allowed it to install
the Mono Framework and also install my app.

After that I exited the emulator and re-started using the IDE instead (which
I assume means it went back to using 512 instead of 1024).  It worked this
time when running from the IDE (although it didn't have to install the mono
framework this time since it was already installed during the last step). 
So it seems to be related to installing the mono framework and it needs
extra memory when it does so for Android platform 2.1 for some reason.  But
after the framework is installed it seems ok so far.

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