Among the victims is Sgt. Ednelson Jeronimo dos Santos Silva, 42, a deputy officer of Rio's Military Police Special Operations Unit (BOPE).
The shooting occurred in the Da Mare housing complex in the Nova Holanda favela (slum) in northern Rio, which has been occupied by police for months as part of the local government's official "peacekeeping" campaign in the often violence-torn slums. The campaign is in preparation for Brazil's hosting of the 2014 World Cup and 2016 Olympic Games in Rio.
Police said trouble began Monday night when police officers launched a manhunt for a group of vandals who had been inciting looting along the city's main Brazil Avenue during anti-government demonstrations.
In an initial exchange of fire, the BOPE officer was killed along with a favela resident. Later, at least 400 members of Rio de Janeiro state's Military Police and the National Security Force swarmed the favela, leading to a second shoot-out which left seven people dead, including six drug traffickers, authorities said.
Another nine people were injured and 10 arrested, including a minor aged 16.
During the operation, police seized more than 10,000 individual packs of cocaine, marijuana and crack, as well as four rifles, two machine guns and five handguns, a bullet-proof vest, printer, two cars and five motorcycles.
Stores and schools were closed following the gunfight.