Soldiers confronted a group of armed men in a forested area in Uri, 100 kilometres (60 miles) northwest of the main city of Srinagar, triggering the shoot-out, Javid Gillani, inspector general of police, said.
"Our information is that three militants were killed and another was injured in the encounter. One more (militant) is believed to be still in the area," Gillani told AFP.
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Two soldiers were also injured during the exchange of fire, he said.
Another police officer, speaking on condition of anonymity, said the group of five had crossed the electrified fence along the border, called the Line of Control, from Pakistan the previous night.
Since 1989, several rebel groups have been fighting hundreds of thousands of Indian government forces deployed in the Himalayan region for independence or a merger of the territory with Pakistan.
The fighting has left tens of thousands, mostly civilians, dead.
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Kashmir has been divided between India and Pakistan since the two won independence from Britain in 1947. Both claim the disputed territory in full.
India often accuses Pakistan of arming and pushing rebels across into the Indian side, a charge Islamabad denies.
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