The dead was identified as Dil Mohammed alias Dilu, 36. He was a 'listed drug peddler' implicated in nine cases, the police said.
He died during a police raid which occurred in Teknaf Sadar Union's Hatchery Zone area early on Wednesday morning, said Teknaf Police OC Pradip Kumar Das.
Police arrested the fugitive drug peddler Dilu at Teknaf Sadar on Tuesday afternoon, said the OC.
"During interrogation, he revealed that he and his associates had hidden a smuggled consignment of yaba tablets and arms in a bush in the Hatchery Zone along Cox's Bazar-Teknaf Marine Drive a few days ago."
A police team was dispatched to the location early in the morning with Dilu in tow, said OC Pradip.
"When the police arrived at the scene, Dilu's accomplices opened fire at them. Police retaliated and at one point, Dilu was shot in the crossfire."
He was subsequently rushed to the Teknaf Upazila Health Complex where doctors on duty declared him dead.
Teknaf Police SI Mohammed Babul and Constable Mohammed Ibrahim were also injured in the shootout, said the OC. They were treated at the Upazila Health Complex.
Police recovered 7000 methamphetamine-based yaba tablets, six guns and 13 bullets from the scene.