Police and soldiers cordoned off a village in northern Kupwara region after they got a tip that militants were hiding in the area, said army spokesman Col. Nitin Joshi.
The fighting erupted Friday evening and intermittent gunfire continued through the night.
An intense firefight resumed early Saturday in which two soldiers were killed and two others wounded, Joshi said.
Police say the bodies of the militants have been spotted and soldiers were in the process of retrieving them.
The area is close to the Line of Control dividing Kashmir between India and Pakistan. Both countries claim the Himalayan region in its entirety.
More than a dozen rebel groups have been fighting in Kashmir since an insurgency erupted in 1989.
The rebels are demanding independence for Kashmir from Hindu-majority India or its merger with Muslim-majority Pakistan. More than 68,000 people have been killed in the fighting and the ensuing crackdown by Indian forces.
India accuses Pakistan of arming and training the insurgents, a charge Islamabad denies.
The two countries have fought two wars over control of the region since they won independence from British in 1947.
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