A number of the injured were in a critical state, a police spokesman said.
The dead included two tourists, including a six-year-old girl, and two of the restaurant's cooks. Police were waiting to inform their families before making their identities known.
The blast occurred in the dining hall of Purnima Hotel at around 4:30 pm (11:00 GMT).
An Islamic armed group, al-Nasirin, claimed responsibility for the attack.
A spokesman for the group claimed the attack in a telephone call to the local Current News Service agency, a police spokesman said. The caller had said, "Indians have no justification in visiting a disputed area."
He also warned the group would carry out similar attacks,
blaming tourists for "spreading obscenities". Al-Nasirin has in the past claimed responsibility for several attacks in the troubled region.
Pahalgam is about 95km southwest of Srinagar, the summer capital of India's Jammu-Kashmir state.