Acting on a tip-off, government forces surrounded a thickly forested area near the northern town of Handwara, 70 kilometres from Srinagar, triggering the clash.
The bodies of the dead were recovered along with their weapons, army spokesman Rajesh Kalia told AFP.
On Saturday two civilians including a 13-year-old girl were killed in heavy cross-border shelling.
Kashmir has been divided since the end of British colonial rule in 1947.
A revolt against Indian occupation over its sector broke out in 1989 and tens of thousands of people, most of them civilians, have been killed since then.
Around 500,000 Indian soldiers are deployed in the region.
Rebels have repeatedly attacked government forces and banks in recent weeks.
Last week suspected insurgents abducted and killed a military officer who was home on leave for a wedding in Shopian district.
Clashes have become more frequent following widespread unrest last year which was sparked by the killing of a popular rebel leader by security forces in July.
Police and Indian army officials say dozens of local youths have joined the rebel ranks since then.
Some 30 armed freedom fighters, mostly locals, have died fighting government forces this year.
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