Greg Sheridan – Want to hear something strange? East Timorese representatives have had discussions with Indonesian authorities about the possibility of Indonesia's armed forces, the TNI, helping to train East Timor's nascent force.

The discussions haven't resulted in any action and may come to nothing. But they are a sign of the intelligent, pragmatic attitude of East Timorese leaders determined to find a fruitful way to live with their giant neighbour.

They also illustrate another key reality we face today. The West, meaning in this case the US and Australia, and the whole Asia-Pacific region, need to come to grips with the central role the TNI is going to play.

Singapore's former prime minister Lee Kuan Yew, traditionally regarded as the most sagacious strategic thinker in the region, put it plainly at the weekend.

"One key institution to hold Indonesia together is the TNI," Lee said. He called on the US to "re-engage the TNI and help it reform itself", adding "the stability of Indonesia is crucial to the future of the region and the strategic balance in East Asia".

Lee pointed out that the vast majority of South-East Asia's 230 million Muslims are moderate and easy to get on with. That is the tradition of South-East Asian Islam. However, he identified three factors that have transformed a powerful minority and had an effect on the majority.

These were: Saudi money, following the oil shocks of the 1970s, flowing in to support narrow Wahabi Islamic institutions in the region; the effects of the Iranian revolution in 1979 and its promotion of Islamic ideology; and the experience of hundreds of South-East Asian Muslims in travelling to Afghanistan to fight with the mujaheddin and then returning to South-East Asia full of fanatical commitment.

This means Islamic fundamentalism is a much bigger threat in South-East Asia than it has ever been before. Moreover, the new atmosphere among Muslims will have deeper political consequences in Indonesia.

Many analysts share Lee's view. Since the fall of Suharto in 1998 there has been a notable lack of the development of any truly national institutions in Indonesia. The political parties are predominantly regional. Even the national bureaucracy is splintered by the move to decentralisation.

The TNI, after its disgrace in East Timor and its heavy-handedness in the last days of Suharto, is an institution that has lost an enormous amount of self-confidence. But it remains the only viable national institution in Indonesia. While most of its officers are Muslim they are generally not sectarian.

The TNI has enormous reform challenges ahead and not only in terms of human rights. More than half its money is generated "off-budget", which means that it is impossible to transform the system of patronage, and much that we would call corruption, overnight.

Moreover, under Suharto the centre could dispense money and exercise influence that way. The centre is much less capable of that now.

Nonetheless the TNI is crucial to Indonesia's future in many ways. It has to demonstrate the viability of national institutions. It has to prosecute the fight against international terrorism. It has to act to prevent, or at least limit, inter-communal violence such as we have seen so appallingly in the Malukus.

In all of this it needs a lot of help. US Deputy Defence Secretary Paul Wolfowitz, a former ambassador to Jakarta and the most influential Bush administration figure on Indonesia, recently drew attention to the possible upside in Indonesia, arguing that "Indonesia's moderate traditions of Islam [are] a potential example for the whole Muslim world".

Wolfowitz is also strongly in favour of resuming military-to-military ties with Indonesia, saying:

"I know not every story of military education is a success story but experience really does show that those officers who've had real contact with the US are much more open in their outlook, much more accepting of civilian control, much more supportive of democracy."

Wolfowitz is dead right. Even if it didn't work with the old Indonesian military, it was never wrong to make the effort to train and democratise them.

All of this poses obviously difficult questions for Australia. Good relations with Indonesia were probably always a vote loser for federal governments but they are essential to promoting Australia's national interest.

Even the Howard Government has found this in its struggle to prevent the arrival of boatpeople. Forcing some boats back to Indonesia has been effective, but so has the operation of Australian police and security personnel, including vast amounts of electronic communications intercepts, which we carry out in Indonesia against the people-smugglers. Without the co-operation of the Indonesian Government and the TNI, this would be impossible.

General Peter Cosgrove has used his unique moral authority to point out that our previous policy of engaging the TNI saved Australian lives in East Timor because it meant he and his commanders knew their Indonesian counterparts and could organise an orderly TNI departure from East Timor after the Australians had gone in.

Defence Minister Robert Hill understands all this. He commented recently: "The TNI is an institution that is critical to the internal stability of Indonesia ... And in Islamic terms it is not an Islamic organisation as such."

Australia now offers some places in staff colleges to Indonesian officers, is looking at joint maritime reconnaissance, intelligence exchange and counter-terrorism training. It's a modest program, and even at this level won't be popular. But it is an absolutely essential start.