Half of the men, women and children refugees were housed in schools and other buildings while the overflow huddled under trees and tents in Kantalai.
Tensions were heightened by a defence department claim that Tamil rebels had massacred at least 100 Muslim men whom they suspected had told security forces about the rebels' movements.
The massacre is said to have taken place 40 kilometers (25 miles) away in Muttur.
There was no immediate reaction from the Liberation Tigers of Tamil Eelam (LTTE) to the claims of a massacre, which came amid complaints that the rebels were holding over 100 Muslim men from Muttur.
The International Committee of the Red Cross (ICRC) said it had no access to the Muttur area and was unable to verify claims of casualties.
"More than 100 innocent youths were detained by the LTTE while they were fleeing to safer places," Sri Lanka Muslim Congress leader Rauf Hakeem said.
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"We urge the LTTE to release them immediately."
Hakeem also accused security forces of s