Indian Prime Minister Atal Behari Vajpayee and Pakistani President Parvez Musharraf met on the sidelines of a South Asian summit, according to Pakistan's Information Minister Shaikh Rashid.
Shaikh Rashid told state television that both countries were working on a 'declaration' after their meeting. "Right now the knots are being unravelled for a declaration," he said.
Earlier, Vajpayee laid the foundation stone for a new residential complex for the Indian High Commission.
"I believe that the building of which I am laying the foundation will withstand every kind of weather or storm," he said.
"It is necessary that the two countries have adequate representation and that dialogue goes on continuously, that we understand each other's difficulties and find a way out together"
Indian prime minister
"People who will be living in this building will discharge their responsibilities. Among those responsibilities is to have good relations with Pakistan. It is a big responsibility."
"It is necessary that the two countries have adequate representation and that dialogue goes on continuously, that we understand each other's difficulties and find a way out together," he said in a speech.
Diplomats call Vajpayee's meeting with Musharraf a step in the process of rebuilding relations and a chance for both men to advance a shaky peace process.
But it is thought unlikely to yield any major breakthroughs in their decades-old dispute over the divided Himalayan region of Kashmir, barring perhaps an agreement to resume a lower-level dialogue.
"It really is a fundamental step forward when you look at how far we've come in the last few months," said one Western diplomat. "But the big question is whether they have moved any closer to each other on the core issue of Kashmir."
Kashmir is the main obstacle to progress between the two countries. It has been divided between the rivals since a war which followed independence. The bitter dispute has cost tens
of thousands of lives since then.
Two years ago, the neighbours again came to the brink of war over Kashmir, after an attack on the parliament in New Delhi that India blamed on Pakistan-backed militants.
Musharraf greets Vajpayee (L) as
Pakistani PM Jamali looks on
But in April, Vajpayee launched a "final bid" for peace in his lifetime. Since then full diplomatic relations have been resumed and some travel links have been reinstated.
Perhaps the biggest breakthrough came in November when Pakistan announced a ceasefire along the front line in Kashmir.
That has since held, though violence has continued in Indian Kashmir between security forces and separatist rebels.
With Vajpayee expected to stand down at elections later this year and Musharraf promising to give up his army uniform at the end of 2004 - although he will remain president - diplomats say both men appear keen to move the process forward.
What is less clear is if they will find any middle ground.
"These are two men who both have an eye on their place in history," said a diplomat. "But there is an awfully long way to
go once the two countries get to the negotiating table over
India controls 45% of the mainly Muslim former princely state of Jammu and Kashmir, including the real bone of contention, the stunning Kashmir valley itself.
"These are two men who both have an eye on their place in history. But there is an awfully long way to go once the two countries get to the negotiating table over
A diplomat at SAARC
Pakistan, which controls about a third of the region, is accused by India of fomenting rebellion in Indian Kashmir. It denies the charge and counters by accusing Indian security forces of widespread human rights abuses in the Kashmir valley.
China controls a small chunk of territory in the northeast.
Vajpayee and Musharraf last held talks at a failed summit in the Indian city of Agra in July 2001, though they shook hands briefly at the last South Asian Association for Regional Cooperation summit in Kathmandu two years ago and did so again before a state dinner on Sunday night.
On Monday, Vajpayee also met Pakistan's Prime Minister Zafar Allah Khan Jamali for about 30 minutes, half of that time