(Recasts with release of separatists)

By Sheikh Mushtaq

SRINAGAR, India, Sept 1 (Reuters) - India authorities released two separatist leaders in Muslim-majority Indian Kashmir on Monday but anger festered against a government deal with Hindu groups to resolve a land dispute that has paralysed the state.

Mirwaiz Umar Farooq, chairman of the main separatist alliance All Parties Hurriyat (Freedom) Conference, and the breakaway hardliner Syed Ali Shah Geelani had been detained for more than a week as authorities tried to defuse separatist protests.

A third leader, Mohammed Yasin Malik, will be released later on Monday night, according to S.M. Sahai, head of police in the Kashmir Valley. Two other leaders remain detained.

At least 38 people, mostly Muslims, have been killed since a row over land for Hindu pilgrims snowballed into some of the biggest pro-independence demonstrations in the Kashmir Valley since a revolt against Indian rule broke out in 1989.

The land dispute has sharply divided Hindu-majority Jammu and mainly Muslim Kashmir, the two main parts of the Indian state of Jammu and Kashmir.

The government announced a deal with Hindu groups on Sunday, sparking celebrations in Jammu.

In Kashmir, however, the deal has been rejected by separatists and some mainstream parties.

The release of the leaders, which comes just before the Muslim holy month of Ramadan, is not expected to end protests. The separatist leaders spearheaded massive demonstrations in the weeks before their arrest.

A curfew remains in place, but more protests are planned, separatists said.

Earlier on Monday, police fired rubber bullets at protesters in Srinagar, Indian Kashmir's summer capital, hitting a roadsweeper in the chest. Residents said the roadsweeper was not a protester.

Most shops remained closed in the city.

Federal police, mostly Hindus who do not speak the Kashmiri language, patrolled nearly every street corner armed with automatic rifles and batons.

Barbed wire cordoned off entire neighbourhoods. Many passers-by stopped to show journalists bruises they said had come from police beatings.

Indian troops have been criticised by Kashmiris and international human rights groups for using excessive force.

COMPROMISE REJECTED

The land dispute began in June after the state government promised to give forest land to a trust that runs Amarnath, a cave shrine visited by Hindu pilgrims.

Muslims were enraged, the government backtracked, and then Hindus protested, blocking the highway to the Kashmir Valley.

The state government has now promised to allow temporary shelters to be built during the annual pilgrimage.

Muslim separatists have rejected the deal. The Peoples Democratic Party (PDP), a mainstream party that believes in Kashmir's unity with India, called the agreement a "move to disrespect the popular sentiments in Kashmir".

One local newspaper on Monday splashed two photos side by side on its front page.

The first showed Hindus celebrating the land deal with a smiling policeman in Jammu. The second showed a Muslim youth lying in hospital after being shot by police, echoing Kashmiri sentiments that India's government favours Hindus over Muslims.

For most Kashmiris, the land dispute was only the spark for wider discontent about 60 years of Indian rule.

"We will continue our peaceful protests. What we want is freedom, nothing else," said Zaffar, a 23-year-old student.

India has intensified a crackdown against separatists and detained at least five separatist leaders, including a top woman leader, in an effort to defuse protests.

Tens of thousands of people have been killed in Kashmir since the armed revolt against New Delhi's rule broke out in 1989. (Additional reporting by Alistair Scrutton in Srinagar; Editing by Simon Denyer and Paul Tait) (For the latest Reuters news on India see: http://in.reuters.com, for blogs see http://blogs.reuters.com/in)

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