Suspected militants are holding six people, including four children, hostage in the Jammu area of Indian-controlled Kashmir, police say.
Soldiers have surrounded the house on the outskirts of Jammu city and the two sides are exchanging fire.
Earlier, the militants clashed with troops, killing three civilians and one soldier. One militant was also killed.
Officials said the rebels slipped into India across the border from Pakistan on Tuesday.
"The infiltrators in police uniform opened indiscriminate fire at several places before barging into a house near Chinore area," a police spokesman was quoted by Reuters news agency as saying.
A senior police official told the BBC that the six hostages include a man, a woman, and four children. He said at least two hostage-takers were also inside the building.
Angry protests
The Hindu-majority areas around the city of Jammu have been the scene of violent demonstrations in recent months.
The Indian authorities are struggling to halt the protests, which were sparked by a dispute between Hindus and Muslims over whether land should be given to a major Hindu shrine in the Muslim-majority Kashmir valley.
Trouble began in June when the state government granted a small piece of land to a trust running the Amarnath Hindu shrine.
Muslims launched violent protests, saying the allocation of land was aimed at altering the demographic balance in the area.
The state government said the shrine board needed the land to erect huts and toilets for visiting pilgrims.
But following days of protests, the government rescinded the order, prompting Hindu groups to mount violent protests of their own.
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