India was to decide its response Wednesday after accusing Pakistan of killing two of its soldiers and mutilating one of the bodies along the tense border between the nuclear-armed neighbours.

Foreign Minister Salman Khurshid said India would deliver a "proportionate response" to the "ghastly" killings in Kashmir on Tuesday which he said were designed to sabotage an already fragile peace process.

The Pakistani military meanwhile rejected what it called Indian "propaganda" that it said was aimed at diverting attention after a cross-border exchange at the weekend in which a Pakistani soldier was killed.

The two Indian soldiers died after a firefight broke out around noon as a patrol moving in foggy conditions discovered Pakistani troops about half a kilometre (1,600 feet) inside Indian territory, an army spokesman said.

A ceasefire has been in place along the Line of Control that divides the countries since 2003, but it is periodically violated by both sides.

"There was a firefight with Pakistani troops," army spokesman Rajesh Kalia told AFP from the mountainous Himalayan region, confirming the names of the men as sergeants Hemraj Singh and Sudhakar Singh.

"We lost two soldiers and one of them has been badly mutilated," he added, declining to give more details on the injuries.

"The intruders were regular (Pakistani) soldiers and they were 400-500 metres (1,300-1,600 feet) inside our territory," he said of the clash in Mendhar sector, 173 kilometres (107 miles) west by road from the city of Jammu.

Indian reports and a military source speaking to AFP indicated that the mutilated soldier may have been decapitated, but further investigations and a post-mortem were required to confirm this.

Speaking on Indian television late Tuesday, Khurshid described the killings as "inhuman" and "not the way civilised people deal with each other".

"We need to do something about this and we will, but it has to be done after careful consideration of all the details in consultation with the defence ministry," Khurshid told the NDTV news channel.

"What will be done, in which manner, is something we will take a call on tomorrow." Khurshid.

"It is absolutely unacceptable, ghastly, and really, really terrible and extremely short-sighted by their part," he added, promising that the response would be "proportionate".

"This seems like a clear attempt to derail the dialogue," he added. "We have to find ways in which the dialogue is not sabotaged or destroyed."

Relations between the neighbours had been slowly improving over the last few years following a rupture in their slow-moving peace process after the 2008 attacks on Mumbai, which were blamed by India on Pakistan-based militants.

In Islamabad, a Pakistan military spokesman denied what he called an "Indian allegation of unprovoked firing", calling the Indian account "propaganda to divert the attention of the world from Sunday's raid on a Pakistani post".

Pakistan's army says Indian troops crossed the Line of Control on Sunday and stormed a military post in an attack that left one Pakistani soldier dead and another injured.

It lodged a formal protest with India on Monday.

India denied crossing the line, but a foreign ministry spokesman said Indian troops had undertaken "controlled retaliation" on Sunday after "unprovoked firing" that damaged a civilian home.

The deaths deal a serious blow to efforts to ease tension in South Asia and improve diplomatic relations. Steps such as opening up trade and offering more lenient visa regimes have been a feature of recent high-level talks.

Muslim-majority Kashmir is a Himalayan region that India and Pakistan both claim in full but rule in part. It was the cause of two of three wars between the neighbours since independence from Britain in 1947.

The last major escalation in Kashmir occurred in 1999 in fighting that claimed the lives of more than 1,000 combatants on both sides after India accused Pakistani militants and troops of occupying strategic Indian peaks.

The last major mobilisation of Indian troops to its border with Pakistan took place in 2001 after an attack on the national parliament in New Delhi by five Islamic militants.