Michaela Kuefner, the Chief Political Editor at DW, Germany's international TV channel, tweeted that in a "modest pre-dinner criticism of the Kashmir clampdown, Merkel said that "the Situation for the people there is unsustainable and not good".
Merkel met Modi for a second round of talks at his 7, Lok Kalyan Marg, official residence.
She had told German media persons accompanying her that she would raise the matter with Modi on Friday evening, though she was aware of India's position regarding Kashmir.
The German Chancellor's statement comes a day after Jammu and Kashmir was officially bifurcated into two Union Territories of J&K and Ladakh.
The visit to Kashmir earlier this week by a delegation of European Union Parliamentary members, that stirred controversy, could also have figured in the talks.
Earlier in the day, Merkel and Modi held the Fifth Intergovernmental Consultations at Hyderabad House after which the two sides inked over 20 agreements.
Earlier, during a ceremonial reception at Rashtrapati Bhavan, Merkel remained seated while the national anthem of both countries was being played. India accepted a request by the German government to allow Merkel to remain seated as she is suffering from a medical condition.
It is learnt that certain provisions of the order relating to the National Anthem of India were invoked to allow Merkel to be seated when the national anthem is played.
However, she was panned on social media for not standing during the national anthem, which is very short.
( With inputs from IANS )