Militants in Indian-administered Kashmir are surrounded by the security forces after attacking a convoy of Indian soldiers near Srinagar, military officials say.
There are unconfirmed reports that they are holding hostages in a government building near the city.
At least one soldier was killed in the earlier encounter, the military says, and several are reported to be wounded.
An armed stand-off in now under way, media reports say.
NDTV reported that government employees trapped inside the Entrepreneurship Development Institute have been evacuated.
PTI news agency said that an unknown number of people were still feared to be trapped inside.
Kashmir, claimed by both India and Pakistan in its entirety, has been a flashpoint for more than 60 years.
The two South Asian rivals have fought two wars over the region in the Himalayas.