It said other police rushed to the scene and shot dead "a number of thugs." One policeman, two hostages and a civilian were also killed, Xinhua said.
"Six hostages were successfully rescued," it said, adding the situation was now "under control."
A woman from the information office of Xinjiang Public Security Department in Urumqi confirmed the attack, but would not give any details. As is common with Chinese officials, she refused to give her name.
Calls to the Hotan police rang unanswered.
Xinhua did not give a reason for the attack. But Xinjiang has been beset by ethnic conflict and a sometimes-violent separatist movement by Uighurs (pronounced WEE-gurs), a largely Muslim ethnic group that sees Xinjiang as its homeland. Many Uighurs resent the Han Chinese majority as interlopers.
Dilxat Raxit, spokesman for the Germany-based World Uyghur Congress, said several sources inside Xinjiang told him the violence erupted when a large group of Uighurs tried to protest in Hotan on Monday morning. A clash broke out between the demonstrators and police, he said, and police opened fire.
More than 100 Uighurs had gathered to demonstrate against alleged illegal seizures of Uighur-held land and to demand information about relatives who they said had disappeared amid a police crackdown that began after riots in the regional capital of Urumqi in 2009, Dilxat said.
Dilxat said he could not identify his sources or say where they were located in Xinjiang for fear they would face official reprisals.
The region has been especially tense since the deadly 2009 clashes erupted between predominantly Muslim Uighurs and Han Chinese migrants. Uighurs attacked Hans, overturning buses and torching shops in the regional capital of Urumqi in a riot the government says killed 197 people.
Predominantly Uighur, Hotan is an oasis town of more than 115,000 people in the southern part of Xinjiang not far from the Pakistan border.
China blames Xinjiang conflicts on what it says are violent separatists working with groups outside China.
It defends its treatment of minorities, saying all ethnic groups in China are treated equally and that tens of billions of dollars in investment and aid have dramatically raised living standards.