Lula took office in a tumultuous scene at the presidential palace, where a protester shouted "Shame!" and the ex-president's supporters chanted slogans accusing their opponents of seeking a "coup."
"The putschists' shouting won't make me veer from my path or bring us to our knees," said Rousseff as she sealed her risky bet to team up again with her old mentor.
Lula, the once wildly popular president who led Brazil from 2003 to 2011, is facing corruption charges and a request for his arrest in connection with an explosive scandal centered on state oil company Petrobras.
The Sao Paulo stock market, meanwhile, shot up five per cent at the opening on optimism that the controversial appointment marks the beginning of the end for the leftist government, which is presiding over the worst recession in 25 years.
"The market is celebrating the end of this government," said economic analyst Andre Leite of TAG Investimentos.