Addressing the Knesset, Netanyahu said that he was open to peace neogtiations with the Palestinians.
"I say to the Palestinian leadership, if you truly want peace, peace can be obtained. With the Palestinian Authority, we will seek peace along three tracks - economic, security and political."
"Its a right-wing government, its a very controversial government, but it can make decisions"
former Israeli diplomat
However, he made no specific mention of Palestinian statehood, a key Palestinian demand that is supported by the United States and other parties involved in mediating between the two sides.
"Under the final accord, the Palestinians will have all the rights to govern themselves except those that can put in danger the security and existence of the state of Israel," Netanyahu said.
Netanyahu also said that he wanted "full peace" with all Arab nations, praising Islam as a rich religion, but he attacked Iran and "radical Islam" as threats to Israel's security.
"Extremist Islam does not only threaten us, but it threatens us first and foremost ... Its goal is to erase the state of Israel from the face of the earth," he said.
The Palestinian Authority described Netanyahu's remarks as "not encouraging".
"The American administration should pressure the Netanyahu government to stick to the fundamentals of the peace process, in other words land for peace," said Nabil Abu Rudeina, spokesman for Mahmoud Abbas, the Palestinian president.
Alon Liel, a former Israeli diplomat, told Al Jazeera: "The most important thing that is happening today is that Israel is getting a government that can deliver.
"Its a right-wing government, its a very controversial government, but it can make decisions. In the last two-and-a-half years after the war in Lebanon ... Olmert was paralysed."
Speaking before Netanyahu, Ehud Olmert, the outgoing prime minister, ended his term with an emotional defence of his premiership, acknowledging that he had mistakes but saying that there had also been successes.
"I accept with love the criticism of the government. I am proud of the government's achievements, which are many, and I am sorry for my mistakes and they are not few," he said.
Olmert stepped down as he was facing multiple corruption investigations.
Critics have attacked the emerging government as bloated, saying that the administration is the result of too many job promises made to sweeten coalition allies.
Olmert's coalition has 27 ministers.
In an editorial, Israel's Haaretz newspaper reminded readers that a member of Netanyahu's own Likud party in the last parliament asserted that anything more than 18 ministers would be a "waste of public money".
There are also concerns about the stability of the coalition as it attempts to bring together the Labor party of Ehud Barak and Yisrael Beiteinu.
Likud is known for its hard line on security issues and conservative economic philosophy, while Labor's approach is relatively moderate and left-leaning.
Yisrael Beiteinu's policies are regarded as far to the right of even Likud.
On the diplomatic front, Israeli policies have been criticised by the Czech Republic, which currently holds the EU presidency.
A planned EU-Israel summit is unlikely to take place in the next three months, Karel Schwarzenberg said on Tuesday.
|Two people were killed and two others injured in an Israeli air raid on Tuesday [AFP]
"We are not happy with some of the steps of the Israeli government, namely construction works close to Jerusalem but also access to Gaza, which is today very limited," the Czech daily Lidove Noviny
quoted Schwarzenberg as saying.
Israel has earned international criticism for restricting traffic on the Gaza border since its December-January offensive against Hamas, which rules the Palestinian territory.
The war killed over 1,300 Palestinians and destroyed some 5,000 homes in the Gaza Strip.
In the latest violence in the enclave, medical workers said that an Israeli air raid killed two Palestinian fighters and injured two other people on Tuesday.
Residents of the nearby Maghazi refugee camp said a helicopter fired two missiles at fighters who had launched a rocket-propelled grenade at Israeli forces. One Israeli soldier was reported as being lightly wounded.
An Israeli military spokeswoman said that fire had been directed against fighters who tried to plant explosive devices along the border fence.