Crowds cheered as he then travelled by motorcade to parliament, where a ceremony kicked off country-wide festivities commemorating independence from Indonesia, which invaded the former Portuguese colony in 1975.

Ramos-Horta, 72, who led the resistance during Indonesia's occupation, called for reconciliation and unity as he took the oath of office shortly before midnight, the time the country declared independence 20 years ago.

"Today more than ever, we must be fully aware that only in unity will be able to achieve the development goals that we propose," he said.

East Timor's transition to a democracy has been rocky, with leaders battling massive poverty, unemployment and corruption as the country continues to struggle with the legacy of its bloody independence battle and bitter factional politics that have occasionally erupted into violence.

Its economy is reliant on dwindling offshore oil revenues.

Ramos-Horta pledged to reduce poverty, improve health services for mothers and children as well as promote a dialogue to restore political stability.

He said he expects East Timor to become the 11th member of the regional bloc the Association of Southeast Asian Nations in the next two years.

Portuguese President Marcelo Rebelo de Sousa and Indonesian Coordinating Minister of Political, Law and Security Affairs Mohammad Mahfud were among those who attended the inauguration.

Ramos-Horta defeated incumbent Francisco "Lu Olo" Guterres, his fellow independence fighter, in an April 19 election run-off.

He held a commanding lead among 16 candidates in the first round but did not receive the 50 per cent threshold required for victory.

More than 76 per cent of the votes went to resistance-era figures, showing how much they continue to dominate politics after two decades.

"He is a great hero in the era of our struggle for independence," Aderito Herin Martins, a resident of the capital Dili, said of Ramos-Horta.

"Now it's time for him to work on the critical issues of poverty and unemployment that still face our country as he promised in his campaign."

The United Nations estimates that nearly half of East Timor's population lives below the extreme poverty line of $A2.69 a day, and for every 1000 babies born in the country, 42 die before their fifth birthday because of malnutrition.

Residents voted overwhelmingly for independence in a 1999 referendum held under UN auspices despite widespread Indonesian intimidation and violence.

The vote had been unexpectedly offered by an overconfident Indonesian government following a long-running but largely fruitless resistance struggle.

Indonesia's military responded to the referendum results with a scorched-earth campaign that left East Timor devastated.

Australia spearheaded a UN military mission to restore order from the chaos as the Indonesian forces left.

It took almost three more years for East Timor - with a population of just over one million people - to become an independent and sovereign country on May 20, 2002.

Australian Associated Press