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By Muklis Ali

JAKARTA, June 13 (Reuters) - Australia and Indonesia agreed on Friday to work more closely on tackling deforestation and to deepen the security cooperation that has helped smooth ties between Canberra and its populous developing neighbour.

Prime Minister Kevin Rudd, who flew in from Japan as part of a trip aimed at setting out his regional agenda, also floated his idea of developing an Asia-Pacific Community by 2020.

Rudd and Indonesian President Susilo Bambang Yudhoyono signed an agreement to combat greenhouse emissions from deforestation, estimated to account for 20 percent of man-made carbon emissions.

"This is important for the future," said Rudd, who inspected a red-coated presidential guard of honour at the colonial-style palace after being met by a thunderous gun salute.

Indonesia, which hosted a U.N. climate change conference in December, has been a driving force behind calls for rich nations to compensate poor states that preserve their rainforests to soak up greenhouse gases.

Rudd has also been attempting to lift Australia's green credentials after ratifying the Kyoto climate pact.

The "Forest Carbon Partnership" agreement aims to provide long-term cooperation on helping Indonesia turn forest conservation into a tradable commodity -- potentially worth billions of dollars.

"We need to set a value -- a real dollar value -- on the carbon stored in rainforests," Rudd told a meeting of business leaders, adding that satellite technology would be used to help.

SECURITY COOPERATION

Rudd said the two leaders had discussed further security cooperation within the framework of the Lombok Treaty, a defence pact agreed between the two countries in 2006 on the Indonesian island of Lombok. He did not elaborate on details.

The treaty aims to expand security cooperation, and also gives underlining support for Jakarta's sovereignty over restive provinces, an issue that has often dogged the neighbours' relations.

Indonesia tore up a defence pact with Canberra nine years ago when Australia led an international force in East Timor to restore order after the territory voted to break from Jakarta.

The two countries' relations also hit a rocky patch in 2006 when Canberra granted protection visas to 43 asylum-seekers from Papua, Indonesia's part of the island of New Guinea, who claimed they were being persecuted at home.

At the news conference Yudhoyono touched on the fight against Islamic militants following bomb blasts in Bali in 2002 and 2005, where many foreign tourists, the biggest number of them Australians, were killed.

"Since then, Indonesia and Australia have agreed that we cannot be defeated by terrorism. We are working together to bring the offenders to the court and then work together to prevent another terrorist attack," Yudhoyono told the news conference.

Rudd, a Mandarin-speaking former diplomat, is also trying to sell the idea of Asia developing a European Union-style community to tackle challenges such as climate change, security and food.

He said that existing regional bodies such as the Southeast Asian grouping ASEAN and APEC still had roles to play, and that his plans did not envisage a loss in national sovereignty.

But he added: "We need to start thinking about how we develop our organisations -- how we get to the next level."

Rudd, who also met the heads of the country's two main moderate Muslim groups, will open an Australian-funded school in Aceh province on Saturday.

Canberra was heavily involved in the aid effort after monster waves from the 2004 Indian Ocean tsunami devastated the province on the tip of Sumatra island and killed more than 230,000 people across the region. ($1=1.065 Australian Dollar) (Additional reporting by Olivia Rondonuwu) (Writing by Ed Davies; Editing by Sugita Katyal and Alex Richardson)

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