On Wednesday a senior Indian Railways official in the state's summer capital, Srinagar, reported receiving a phone call in which five million Indian rupees ($110,000) was demanded as a condition to set free one of the organisation's employees - an engineer.
The caller reportedly did not say when and where the money had to be delivered.
Police said they were investigating the incident - the first in strife-torn Kashmir involving railway workers - and that they had launched a massive search operation.
The Indian Government has been laying a railway line between Qazigund - the "gateway to the Vale of Kashmir" - in the south and Baramulla in the north, covering a distance of more than 100km.
Attacks aimed at security forces
regularly kill civilians in Kashmir
Due to be completed in 2007, the project will give the valley - perched in the Himalayas at an average height of 5000ft - its first ever rail network.
Indian officials are counting on the service to help kickstart the state's ailing economy and thus end the feeling of alienation among Kashmiri Muslims that they believe fuels separatism.
A low-intensity war in Kashmir between Indian security forces and separatist groups has not only claimed thousands of lives over the past 15 years, but also played havoc with the state's economy.
In a separate incident on Wednesday, at least 22 civilians, including five women, were wounded in a grenade explosion in Bijbehara, a highway town about 50km south of Srinagar.
Police said rebels tossed the grenade at a vehicle carrying Indian security forces but missed the target. It fell and exploded on the edge of the road, striking passersby and shopkeepers.
Soon after the attack, a bomb exploded near a bank in the same town but no one was injured.
Bijbehara is the electoral constituency of Kashmir's chief minister, Mufti Muhammad Sayeed, who recently told a visiting European Parliament delegation that peace and normalcy are fast returning to the state.
John Walls Cushnahan, the head of the seven-member EP team, said soon after arriving in Srinagar on Tuesday that India, Pakistan and the people of the region need to deal with the Kashmir dispute amicably because it is a potential nuclear flashpoint.
"The people of Kashmir are the most important party to the issue because it is they who are suffering," he said. "We are concerned because Kashmir has been a nuclear flashpoint."
Cushnahan's statement came just days after European Union ambassador to India, Francisco da Gamara Gomes, suggested that the EU considered Kashmir to be an integral part of India.
Gauging the popular mood is the
aim of a visiting EU delegation
The "nuclear flashpoint" remark of the EP delegation member is being interpreted in local circles as a bid to put the controversy stirred by Gomes' comments to rest.
It is also believed that Cushnahan's description has pleased hardliners in the separatist camp who had strongly objected to the EU ambassador's perceived pro-Indian utterance.
Pakistan had described the envoy's remarks as "unrealistic" and a "negation of the historical fact of the Kashmir dispute".
Over the past couple of days, in an effort to understand the situation on the ground, the EP delegation has met with both pro-Indian and separatist politicians; Indian army generals and police and civil administration officials; civil-rights activists; journalists; and community leaders.
Meanwhile, Indian security forces said they shot dead three alleged infiltrators overnight soon after they sneaked into their side of the Line of Control - the de facto border that splits Kashmir between India and Pakistan.
The dead men were identified by the Jamiat al-Mujahidin group as "district commander" Gulzar Ahmed and his comrades.
Several senior rebel commanders
have been slain in recent clashes
The group said the slain members had been imparted "special target training" and were on an "important mission" in Kashmir.
It claimed that one junior commissioned officer of the Indian army and eight soldiers were killed in the gunbattle. Indian army officials denied any losses.
Six suspected separatists were killed in a neighbouring village under similar circumstances on Saturday night.