At least two soldiers were killed and 24 other people wounded in a battle that began on Friday after the suspected separatists launched a deadly grenade attack, said Gopal Sharma, the director general of police.
"The operation has ended with the recovery of the bodies of two insurgents," Sharma said.
Two policemen and three paramilitary soldiers were wounded on Saturday when security forces tried to storm one of the buildings where the separatists were thought to be hiding, said senior police officer SA Sayeed.
"They fired heavily as a group of police and paramilitary soldiers tried to storm one of the buildings," Sayeed said.
On Friday, the attackers hurled a grenade at a police Jeep and began firing into a security post on the central boulevard of Srinagar, the summer capital of the Indian-controlled portion of Kashmir, a Himalayan territory also claimed by Pakistan and divided between the two countries.
As security forces fought back on Friday, the attackers set off another grenade, wounding several civilians. The attackers slipped into the nearby buildings during the ensuing confusion, Sayeed said.
Witnesses said close to a 1km radius had been cordoned off by hundreds of troops, who were backed by armoured vehicles and trucks mounted with machine guns.
Television cameramen and photographers who had rushed to cover Friday's firefight got caught in the crossfire.
Seven were hurt, including a cameraman who was in a critical condition after being shot in the stomach.
The city centre is quieter than
usual, as many felt safer indoors
In Srinagar, the streets were quieter than usual as many people stayed indoors to keep out of trouble.
Two Muslim groups fighting New Delhi's authority over Kashmir, al-Mansuriyan and Jamiat-ul-Mujahidin, claimed responsibility for the raid.
New Delhi has said that despite a peace process with nuclear rival Pakistan, Islamabad allows separatists to infiltrate into Indian Kashmir from the Pakistani side of the disputed Himalayan region.
Officials say there has been a surge in incursion attempts across the military ceasefire line that divides Kashmir in recent weeks as snow melts in high mountain passes.
The chief of Kashmir's ruling People's Democratic Party said separatist fighters were launching dramatic attacks to derail the peace process.
"We will not let this happen," Mehbooba Mufti said.
On Friday, Pakistani President Pervez Musharraf tried to ease Indian concerns over reports that separatist camps were re-opening on his country's side of the line, saying the situation was "on the mend".