Moscow's generals were preparing for a "large-scale" military operation against guerrillas surrounding at least four villages in Dagestan - a republic in the Russian Federation.
About 1,000 Dagestani police were reportedly gathering in the north Caucasus republic beside troops from the Russian Interior Ministry and the army.
Several thousand refugees were said to be pouring out of the mountainous conflict zone, which came under missile fire from Russian helicopters on Saturday amid some of the worse fighting since the end of the Chechen war in 1996.
Witnesses told Interfax news agency that the gunmen were Wahhabi militants seeking to establish an independent Islamic republic in union with Chechnya. The paramilitaries - who took local men hostages - were mostly Chechens, led by Shamil Basayev, they said. Mr Basayev, a feted Chechen commander, is regarded by Moscow as a terrorist.
The stand-off was sufficiently serious for President Boris Yeltsin to order his Prime Minister, Sergei Stepashin, to Dagestan for a four-hour visit. Two senior generals - the chief of staff of the Russian armed forces, General Anatoly Kvashin, and the commander of the Interior Ministry troops, Vyacheslav Ovchinnikov - were also dispatched. The latter is to oversee the operation.
Mr Stepashin, a former interior minister and ex-head of domestic intelligence, played a part in the sending of forces into Chechnya in 1994. Yesterday he said he was "not afraid" of taking on the guerrillas but ruled out a new war.
The precise number of Islamic fighters surrounding the villages - Ansalta, Echeda, Miarso and Rokhota - was unclear. Initial estimates put them at 200 although the Russians talked of as many as 2,000. News that their leader is believed to be Mr Basayev horrified Russians. He led a flamboyant raid into Russia in 1995, taking 1,000 hostages. To Russian disgust, he and his men negotiated free passage home.
He leads an organisation called the Congress of the Nations of Ichkeria (Chechnya) and Dagestan. Sources within the congress told Interfax that the Islamic fighters in Dagestan were setting up a local government and Sharia courts in the seized areas. Pro-Wahhabi TV broadcasts were also being beamed into the area.
Russia's border area in the north Caucasus has long been unstable - with regular bombings, wholesale kidnappings, and fire fights between Russian forces and local paramilitaries. But the possibility of a new war there is a nightmare for Moscow. Defeat in the 21-month Chechen war taught it the impossibility of controlling a mountainous Muslim region which has never accepted rule by Orthodox Russia.
Yet the latest events - which follow weeks of skirmishing - place Moscow in a quandary. Dagestan provides access to the Caspian Sea, and is a trans-shipment route for oil. Its loss would been seen in Moscow as evidence that Islam is making dangerous incursions. At present, secession looks improbable. Dagestan, with some 30, often divided, nationalities, is riddled with clan conflict and organised crime. Much more likely is a slide into local civil strife, which Moscow will - with difficulty - try to control.