Australia said it would relax restrictions on defence co-operation with Burma, as President Thein Sein made the first visit by a Burmese head of state to Australia since 1974.
Prime Minister Julia Gillard said the increased engagement was in recognition of Burma's "critical reforms".
Western governments have welcomed increased political freedom in Burma.
However, campaigners had urged Australia to raise human rights concerns with Thein Sein.
The two leaders met on Monday and gave a joint press conference at Australia's Parliament House. The Burmese president's visit is expected to last until Wednesday.
While Australia's arms embargo would remain, Australia would increase military engagement with Burma and send a defence attache and trade commissioner to the country, Ms Gillard said.
"Australia wants to encourage the development of a modern, professional defence force in [Burma] which continues to support democratisation and reform," she said, adding that they would build the defence relationship "carefully, on a step-by-step basis".
Australia would also provide $20m (£13m) in aid for "strengthening democratic institutions, promoting human rights, improving economic governance and advancing the rule of law," she added.
Thein Sein said he was proud to be the first head of state to visit Australia in almost four decades.
He also said that he hoped Australia would understand the enormity of the reforms Burma was undertaking.
"What we are undertaking has no parallel in modern times," he said via an interpreter at the press conference. "It is not just a single transition, but three together."
"It's a transition from military rule to democratic rule, from 60 years of armed conflict to peace and from a centrally controlled and isolated economy to one that can end poverty and create real opportunities for all our people."
Australia's arms embargo outlaws the supply of arms to Burma, as well as training or assistance related to military activities. However, joint training exercises and co-operation in peacekeeping and disaster relief will now be permitted under the new agreement.
Australia also lifted travel and financial sanctions against Burma in June 2012, in support of the country's democratic reforms.
Burma installed a nominally civilian government in March 2011, ending almost half a century of military rule. It has since brought about a series of political and economic reforms.
The country is eager to revitalise its economy by overhauling its infrastructure and attracting foreign investment.
However, activists have cautioned that the reforms could stall, and that the issues of political prisoners and violence against ethnic minorities remain to be resolved.
Thousands of Rohingya Muslims have been displaced by ethnic violence in western Burma's Rakhine state, while in recent months there has been conflict between ethnic Kachin fighters and the Burmese military in the north-east.