Monday's handover began with 64 Indian prisoners who crossed into India via the Wagah crossing, said Kamal Shah, secretary of Pakistan's Interior Ministry.
Some 435 Indian prisoners, including 371 fishermen, and 159 Pakistanis, including 51 fishermen, were due to be exchanged on Monday, according to Aljazeera's correspondent in Islamabad.
All of them served out their sentences but had languished in prisons because of the diplomatic hostility between the two countries.
Most of them are farmers and fishermen caught on the wrong side of the border, but their convictions also include spying and visa irregularities.
It is the biggest mass repatriation since India and Pakistan began a sweeping process last year to ease almost six decades of hostility, marked by three wars.
Hundreds of relatives gathered on each side of the border gate, waving their national flags, while musicians beat drums and played bagpipes.
Prisoners include alleged spies,
criminals and immigrants
The returning prisoners received garlands of flowers as they walked back onto home soil.
The peace gesture comes before a 14 September meeting between Indian Prime Minister Manmohan Singh and Pakistan President General Pervez Musharraf on the sidelines of the UN General Assembly session, expected to focus on the two countries' core dispute over the divided Himalayan region of Kashmir.
'Improvement in trust'
In the last round of peace talks on 30 August, officials from both sides agreed to release all civilian prisoners who have completed their sentences and whose nationality has been confirmed.
"It is a big breakthrough. There has been a lot of improvement in trust between the people of the two countries," Shah said.
"It is a big breakthrough. There has been a lot of improvement in trust between the people of the two countries"
Secretary, Pakistan's Interior Ministry
In past decades, hundreds of Pakistanis and Indians have been caught on the wrong side of the border and imprisoned on suspicion of spying.
Nearly all say they accidentally wandered across the poorly marked frontier.
Pakistani President General Pervez Musharraf said on Friday his country was prepared to be "unilaterally lenient" in such cases in the future. "They are poor people. What are we doing spoiling their lives?" he said in an interview with The Associated Press.
However, Musharraf has not decided whether to allow a mercy petition from alleged Indian spy Sarabjit Singh, whose death sentence for a string of bomb blasts in Pakistan in the 1990s was recently upheld by Pakistan's Supreme Court, triggering protest rallies in India.
Returning to life
Pakistan released 589 Indians last year, and India released 182 Pakistanis, as tensions between the nuclear-armed neighbours eased, according to Pakistani officials.
Indian officials say Pakistan still holds 371 Indian fishermen, 74 other civilian prisoners and more than 50 prisoners of war. Pakistan says 379 Pakistanis are in Indian jails.
The prisoners said they were excited about resuming their lives.
"I am going home. I will sell vegetables again," said a Pakistani prisoner who identified himself only as Qaiser.