At the edge of a vivid green rice paddy, a farmer offers a share of his breakfast to unseen spirits. He arranges slices of banana and a handful of rice on a tray woven from palm fronds, burning a stick of incense to mingle his prayers for a rich harvest with the fragrant smoke that now drifts across the slopes. Rays of sunlight emerge between trees heavy with coffee beans and golden coconuts, carving through a cloud of mist that rests like a soft pillow on the valley below.

Cockerels appear from patches of dense tropical foliage to make their abrupt announcement of the arrival of dawn. Layers of sound fold one over another, the low beat of a dragonfly's wings joined by the calling of crickets, the clucking of a mother hen with her chicks, and the thrum of a motorcycle passing in the distance.

This close to the equator, life abounds. Hedgerows overflow with mangosteen, pineapple and papaya. Flocks of brilliant white egrets settle on the terraces of the rice fields, hungrily watching for fish in the clear waters that trickle through.

Another sound adds to the symphony of this landscape awakening from its slumber: the rhythmic sweeping of brooms in the courtyards of nearby dwellings. Parents and grandparents trim cascades of bougainvillea and frangipani, brushing away the fallen blooms, as children in crisp uniforms head off to school carrying simple twig brushes and sharp sickles to tidy the playgrounds.

Today as most days, offerings are being placed in the doorways of the houses and ornate family temples, at ground level to ward off demonic spirits and higher up to welcome the sun. Ritual is intricately woven into everyday life here. 'The people show such respect,' says Mr Agung Rai, a guide and ambassador of sorts for the district surrounding the town of Ubud, the geographical and cultural heart of Bali.

Agung Rai was born to a family of farmers who can trace their history back to the 14th century. In the 1970s he invited some of the first backpackers passing through Bali to stay in his family's simple one-room ancestral home, and to learn of the island's unique traditions. He invested in a motorbike to carry them around, sold them a few paintings and started down the road that would one day see him create a gallery, a boutique hotel and a beautiful museum of art in Ubud. He has travelled to Europe to buy and bring home Balinese paintings and weavings collected during the time of Dutch colonial influence over Indonesia - in the 19th and early 20th century - and has set up schools for local children to learn traditional forms of dance, music and painting.

In the most humble detail, he sees wonder. 'It's not just clean here, it's artistic. Look, a living sculpture, the controller of the village,' he says as he points to a gruff dog watching us from a gatepost. Dogs are said to have an instinctive ability to detect the demonic spirits that are so significant to Balinese beliefs, their barks being welcomed at night as they chase negative forces away.

As we head back out into the paddy fields, he lights a clove-scented cigarette and points to the shadowy, still-active volcano that shares its name with him - Gunung Agung, the tallest, most sacred mountain on Bali, from which rivers are said to flow and the volcanic soil gains its rich fertility. He smiles as we encounter what he terms 'a Balinese tractor': another farmer, this time attempting to guide two small chestnut-brown cows and a plough through freshly harvested land, knee-deep in mud and water.

Abundant rice harvests are common on Bali, and reveal the benefits of pulling together. For at least a millennium organisations of rice farmers have existed, today known as subaks and often led by the farmer whose plot is at the lowest point on a terrace of rice paddies. His job is to make sure that water is distributed equally between every village and plot of land in the area. The members of the subak meet in their own temple to arrange repairs to the maze of irrigation channels that sustain them, and to plan when to start weeding, ploughing, planting, harvesting or even allowing flocks of ducks in their fields. 'It is very rare to see conflict. The temple helps to unify the members,' says Agung Rai. 'They believe that god is their witness and they cannot lie.'

Bali is made up of communities within communities, and communities overlaying other communities. Houses tend to be passed through families rather than sold, rice fields are shared with those who need them the most, the religions of others are respected, and it's a matter of deep-held belief that visitors should be greeted with warmth. Families, clans, villagers, royalty, fishermen and rice farmers - most are guided by a trust in karma and a set of ancient rituals followed in the many thousands of temples spread across this island, which is barely 90 miles long.

Dewi Sri is the Balinese Hindu goddess of fertility and prosperity, and it is to her that the rice farmers so carefully present offerings in the simple bamboo shrines at the edge of each field, just as we had witnessed earlier. The deity's figure is identified with the rice spirit that had been worshipped by the original people of Bali, before Indian traders brought the Hinduism that became widespread in the 7th century. Waves of Hindu migrants and rulers arrived in Bali in the centuries that followed, determinedly escaping the spread of Islam through Java and the surrounding islands. While 93 per cent of Bali's population is officially Hindu, the version of the religion practised here is like no other. Influences of Buddhism and Confucianism can be found - again relics of waves of migration traceable to lands as distant as northern India and China - and the animistic beliefs of the indigenous Balinese remain a guiding influence for much of daily life.

Demonic spirits are said to lurk all around, with landmarks and prominent natural objects their favoured hiding places - crossroads, graveyards, rivers, large rocks, particular trees. From a marketplace to a school to the grounds of a luxury resort, shrines are built so offerings can be left to keep these spirits content.

One of Bali's grandest temples lies just 10 minutes from the chaotic streets of Ubud. The jungle itself appears to have given birth to the Pura Samuan Tiga, a sprawl of monumental gateways, staircases, and pavilions for joyous dance performances, sacrificial cockfights and the solemn placement of offerings. The temple dates from the 11th century, was rebuilt after an earthquake in 1917, and has always been known as a place of religious unity - the marriage of Buddhist Balinese king Udayana and Hindu Javanese princess Mahendradatta are woven into the legend of its origins. Guardian spirits are represented by fearsome sandstone statues, wild eyed, teeth exposed, clad in thick coats of moss and lichen. A great banyan tree looms over the temple, its long tendrils grasping at the soil below; this is 'the king of the king of all trees,' says Agung Rai, and a formidable home for the spirits that live within.

Clapping and singing echo across the central courtyard, as a teacher leads a group of doll-like eight- and nine-yearold girls in a dance lesson. Sashes are pulled, arms gently twisted, eyes encouraged to flick dramatically left then right. Intense concentration swaps for giggles as one of the girls stumbles a fraction while trying to keep time with the heart-clutching melody of the song.

Anna, Citra, Riska, Meri and Tari live in villages spread across the Ubud district and gather to practise their dance moves three times a week. Their teacher, Ni Luh Mas Sriyati, was born into a line of performing artists and musicians. She started learning to dance at the age of eight and by 10 had ventured on a month long tour of Australia. 'In Bali we have a special culture,' she says. 'In many of our ceremonies, dancing is still connected with prayer. We feel that if we do not learn how to dance, life is not complete.'

The girls have just begun to learn Rejang, a dance so holy that it can only be enacted within temples. 'This has to be performed with great passion,' says Luh Mas. 'The more slowly the movements are made, the more clearly they can be expressed.' Pendet, a dance to welcome guests, is next. The girls' teacher looks proud as she says, 'They so enjoy dancing, they have such a great time.' As she again sings, their tiny arms sway in unison, casting flowers out from an offering bowl - sweet-scented frangipani, rose petals, the blooms of a hydrangea. In this still and sacred place, it's a blissfully cheerful sight.

Luh Mas explains that while some boys learn to dance, more prefer to join a gamelan band. This is an orchestra of many wooden- and brass-keyed instruments, typically accompanied by bamboo flutes, drums, gongs and cymbals. The gamelan needs perfect synchronisation between its members. The music they create is intended to act as the soundtrack to the strangest dream you ever had, something otherworldly and mystical.

Wander through the villages of Bali and on most days you will happen upon a ceremony of some sort, played out to the shimmering sound of a gamelan. That could be a tooth-filing ritual: a celebration of coming of age where teenagers have their front teeth slightly flattened - pointed incisors are a sign of possession by demonic spirits. Or a Barong dance, in which the equivalent to a Chinese dragon battles with an effigy of Rangda the witch, bringing spiritual balance to the place where it's performed. Or today, as the sun tips back towards the mountains, a mass cremation.

On a lane straddling a rice paddy and a coconut grove in the village of Klusu, the gamelan goes into overdrive. 'They are energising the spirits of the dead,' shouts Agung Rai, as the volume mounts.

The purpose is to give the dead the most positive send-off imaginable, preparing them for reincarnation. Family members and neighbours have spent the past two weeks crafting spectacular sarcophagi, each representing the caste of the person whose recently exhumed remains will be carried within. Lined up ahead, these take the form of two black bulls, a white bull and a scarlet tiger. Offerings are blessed by a priest - water from Bali's holiest places, a stuffed bird of paradise to help transport that person's spirit upwards, a choice of sarongs to be worn at the moment of judgement.

The gifts to the gods are paraded towards the graveyard by the women of the families of the dead, while up to 25 men raise each sarcophagus aloft on a bamboo cradle. The men cheer as they surge forward, spinning around at a crossroads to shake off demons, ducking beneath a power cable, driven on by the music of the gamelan.

The sarcophagi are arranged at the graveyard, with offerings laid inside and firewood stacked below. An ice-cream seller is drawn to the crowd and pulls up on a motorbike, a synthesised nursery rhyme playing from a pastel-pink speaker slung over the side. The plinky-plonk tune accompanies the lighting of torches, the smoke of the burning funeral pyres soon blackening the sky. 'The spirits will now be purified,' says Agung Rai. 'It is a reason to smile.' The families will be hoping to greet those same spirits in the future. A month after a child is born, a priest will be asked if they are a relative returned.

As evening approaches, the ashes from the cremation are placed in a river, in the same waters that have cleansed the villagers and irrigated their rice fields. The azure ocean awaits these final mortal remains. For now the visit to this blessed island is over for the spirits of the loved ones lost; they leave in the certainty that they will always be welcomed back.

Peter Grunert is the editor of Lonely Planet Magazine and was visiting Bali for the first time.