The alleged fighting erupted around a house in Jamia Nagar, in the south of the capital, when police acting on a tip-off discovered a group of around five armed men holed up in a building in a maze of narrow streets.
"Our people fear that the police are not impartial. Our people fear that our children are being targeted," said Faiyaz Ahmad Khan, an engineering professor at the city's Jamia Millia University, who was at the scene.
"The Muslims here are saying the incident has been faked. To catch one man they kill 100 innocents." Indian police claimed a key man suspected of involvement in the wave of bomb attacks on Indian cities has been killed in a Delhi shootout in Delhi.
Talking to reporters, New Delhi Police Commissioner Y S Dadhwal claimed, "In this operation, Atif alias Bashir, who was one of main leaders of the Indian Mujahideen, was killed. He is linked with the blasts all over the country,".
The police official said the operation ended with two activists dead and one in custody. Two others managed to flee.
New Delhi was rocked by blasts last Saturday that left 22 dead. The dramatic shootout in India's capital came a day after the government unveiled new security measures designed to tackle what Indian Prime Minister Manmohan Singh said were "vast gaps" in intelligence gathering on militants. After the gunbattle Friday, the mood in the neighbourhood near the capital's Islamic university was tense with local young men watching suspiciously as hundreds of police poured in. Local leaders tried to get the crowd to disperse by calling them for afternoon prayers.