Visiting Deputy Prime Minister Julia Gillard launched the institute at a function here and described it as a think-tank on bilateral issues.
The institute, to be built at a cost of 8.106 million Australian dollars (Rs 32 crores), will be set up at University of Melbourne. University of New South Wales and La Trobe University will also be a partner in the project, she said.
"The institute will be a think-tank on all issues of Australia-India relationship. It will facilitate the growth of relationship between both the countries by carrying out joint research in key areas," she said.
She said the key areas of cooperation are regional relation, environment, climate change, water security and educational collaboration among other things.
She said there are 135 institutional links between Indian and Australian universities at present.
The National Institute for Public Finance and Policy (NIPFP), a leading policy making body in India, will be involved in the joint research programmes.
"We will work in the areas of public finance, tax policy, macro economic management and urban development," Sudipto Mundle, Emeritus Professor, NIPFP, said.
The institute will work closely with the Australia-India Business Council to support mutual trade and investment.
It will also support research, graduate training, executive briefings and policy advice for mutual benefit of both the nations.
As part of cooperation, a conference is being held this month in Delhi to discuss the issue of water crisis. Prof John M Webb from University of Melbourne said cities of both the countries face similar problem of water crisis and the cooperation would be of immense benefit.
The institute will help students, staff and the Australian community to gain greater understanding of India and the bilateral issues.
This initiative assumes significance as both the countries are also expected to sign a free trade agreement soon. The two countries have started a feasibility study on the subject which is expected to be completed shortly.