Police say the car bomb exploded close to a school in the busy market town of Pulwama, about 50 kilometers south of Srinagar.
The deputy inspector general of Pulwama, Sheikh Owais, says the blast occurred just before noon Monday.
Mr. Owais said the bomb damaged the school, a post office and many shops.
Chaos ensued in the small town following the explosion, as residents poured into the streets shouting angry slogans. Police fired in the air to disperse the demonstrators.
India blames most such attacks in Kashmir on Islamic rebel groups waging an insurgency since 1989 to separate Muslim-majority Kashmir from mostly Hindu India.
The bomb attack took place only hours after the Indian and Pakistani leaders had expressed their determination to solve the dispute over the divided region, which both countries claim.
Pakistani President Pervez Musharraf said on Monday in Malaysia that he was hopeful of a quick solution to the Kashmir dispute with India, because leaders in both countries had the political will to reach a conclusion.
On Sunday, Indian Prime Minister Manmohan Singh said New Delhi wanted to return peace to Kashmir.
On a visit to troops manning the Siachen Glacier in Kashmir, Mr. Singh said he wanted to turn the world's highest battlefield into a "mountain of peace."
But rebel groups have vowed to pursue their armed struggle to free Kashmir from India. The violence has so far claimed more than 40,000 lives.