The grenade attack in Uri on Thursday, near the ceasefire line dividing the disputed Himalayan region between India and Pakistan, was the first poll-related violence in the state ahead of Indian parliamentary elections later this month.
The blast sent people fleeing in panic. Police said security forces fired into the air to scare away the fighters.
"I could see many lying in pools of blood. There were screams and shrieks from all sides," said Fayaz Ahmad, a cameraman for Asian News International.
Police said 16 others, including the chief commander of a separatist group, were killed and 16 soldiers wounded in violence across the state where a revolt has raged against New Delhi's rule since 1989.
The election rally blast occurred just as state Finance Minister Muzaffar Hussain Beigh and Tourism Minister Ghulam Hasan Mir were entering a school yard accompanied by several thousand cheering supporters, police said.
The two ministers were taken to hospital where they were in stable condition.
A man identifying himself as a spokesman for Jamiat al-Mujahidin, a small Pakistan-based group of Kashmiri fighters, claimed responsibility for the blast.
"Our mujahidin have carried out this attack," the man told Reuters by telephone in Muzaffarabad, capital of Pakistan administered Kashmir. He declined to give his name or any other details.
The fighters have urged Kashmiris
to boycott the upcoming elections
The pro-Pakistan Jamiat al-Mujahidin, or Group of Holy Warriors, is on the US "terror" watchlist.
But AFP reports that a lesser known group, the Save Kashmir Movement, claimed responsibility for the attack in a telephone call to a local news agency.
"The spokesman of the group has warned of more attacks on election rallies," the Current News Service news agency said.
Rebel groups have told Kashmiris to stay away from India's elections to be held in four stages in Kashmir from 20 April to 10 May, warning them of dire consequences if they take part.
Separatist politicians have also urged a boycott, saying the elections will not resolve Kashmir's future.
Meanwhile, Indian troops Thursday shot dead the chief commander of the Jaish-e-Muhammad group, his deputy and three senior commanders, in northern Kupwara district, a police officer said.
An army spokesman said four soldiers and a divisional commander of Lashkar-e-Taiba died in a gunbattle in Kupwara district.
Sixteen soldiers were injured, three seriously, he said. Three other separatists, two Muslim civilians and an alleged police informer were killed in other incidents, the army spokesman and police said.