Kashmir police officials on Thursday identified the dead man as Manzoor Ahmed Butt alias Manzoor al-Islam alias Darjee, and described him as the "chief field commander" of Jamiat al-Mujahidin.
Jamiat al-Mujahidin is one of the many armed Islamist groups fighting to make Kashmir a part of neighbouring Pakistan. It has yet to react to the announcement of Manzoor's death.
In overnight clashes, three other separatist fighters and two civilians were killed in different parts of Kashmir, the police added.
The police said Manzoor was among the state's "most wanted terrorists".
The fatal encounter occurred on a bypass road connecting Srinagar with major other towns in the north and south valley of Kashmir, the officials said.
The killing came hours before the arrival of India's president, APJ Abd al-Kalam, who is scheduled to inaugurate a university in the winter capital, Jammu, and address students and faculty of a technical institute in Srinagar.
According to the official account, Manzoor was driving through Srinagar on Wednesday evening when security forces signalled him to stop.
At this point, he opened fire at the security men in an attempt to flee.
Civilians have often been caught
in the crossfire in recent months
"Fire was returned, killing him on the spot but another person travelling with him jumped out of the car and ran away," a senior Kashmir police official said, adding that a manhunt was under way.
A Kashmiri-language newspaper, however, quoted "eyewitnesses" as saying that Manzoor was dragged out of the car and shot dead at pointblank range.
Local police said they were informed about the clash at around 10pm (local time).
"When we reached there we saw the bullet-riddled body of a young man lying on the road near a car which had blood marks on it," said a policeman.
The body was removed to the nearby police station where Manzoor's uncle Tanveer, an attorney, identified him on Thursday morning.
Schools and government offices
need heavy military protection
Manzoor was among a group of Kashmiri youths who turned to the gun in the summer of 1989 to fight Indian control over the state.
At first, he joined the pro-independence Jammu Kashmir Liberation Front and was soon arrested. After spending 10 years in prison, he was released in April 2002, whereupon Manzoor joined a moderate political group, Jammu and Kashmir Democratic Liberation Party.
About ten months ago, Manzoor left it to join publicly another separatist group, Mahaz-e-Azadi (Independence Front). But police said Manzoor had secretly moved over to Jamiat al-Mujahidin, one of the many Muslim rebel groups.