Four civilians were killed when Indian soldiers surrounding a house in the village of Ali Brad Bahak returned fire after rebels shot at them.
One pro-government fighter accompanying the soldiers also died.
A military spokesmen said the Indian army received a tip-off the house was being used by Muslim fighters.
“When the troops were laying cordon around the house, the militants opened fire,” the unidentified spokesman told Reuters.
“The fighting has stopped, but Indian troops are still searching the area for militants,” he added.
Ali Brad Bahak is in southern Kashmir's Anantnag district. The rebels escaped, police said.
Police said that four members of the same family - including a mother and her baby - were trapped inside the besieged house. They were all killed in the ensuing battle.
In a separate incident, a woman and her three-year-old her son were killed Thursday when Pakistani troops fired artillery shells across the Line of Control dividing the region, police told AFP.
The attack happened in the Drass region, the scene of a bitter conflict between Indian troops and Pakistan-backed intruders four years ago.
Kashmir is in the grip of an anti-Indian rebellion that, since 1989, has left more than 38,000 people dead, according to Indian government figures. Separatists say the toll is as high as 100,000.
Three rebels and two civilians were killed in other battles across the Himalayan region, police said.
India accuses Pakistan of bankrolling Muslim training camps and arming fighters.
Pakistan has said it provides nothing more than moral support to the militia groups, some of which are fighting for an independent Kashmir and others for unity with Pakistan.
The nuclear neighbours have fought two of their three wars since independence in 1947 over the region.
Last year, relations slumped to their lowest ebb with both countries amassing troops on their respective borders and threatening atomic strikes.
A bus route linking the Indian-administered part of Kashmir, and that controlled by Pakistan, was started up again in early July as a confidence building measure.