(Updates with higher death toll)

By Nigam Prusty and Bappa Majumdar

NEW DELHI, Sept 27 (Reuters) - A bomb exploded in a crowded market in India's capital New Delhi on Saturday, killing two people and wounding 22 others, police said.

The government described it as an "act of terror".

Witness Raj Singh Daswal said he saw two men on a motorcycle drop a black plastic bag that was picked up by a boy.

"He ran after the men telling them 'uncle, uncle you dropped something'," Daswal told Reuters. "Immediately after, there was a huge explosion. The boy's head was blown off."

Police said the second victim was a 60-year-old man who died in hospital.

The bomb left a crater in the road. Police cordoned off the blast site to keep away a crowd of hundreds of people. Many, including wailing women, tried to break through the cordon.

People were seen walking in blood-stained shirts. Locals carried the injured to hospital. Bomb experts picked through debris for clues and sniffer dogs were brought in.

The street in Mehrauli, where the bombing took place, is a mixed area with small mosques and some ancient stone Muslim buildings mixed in with small shops and homes, and close to the Qutab Minar monument which attracts thousands of tourists.

Police evacuated people from all major markets in the city and said ammonium nitrate could have been used in the blast.

"We are looking for the motorcyclists," police spokesman Rajan Bhagat said.

Hundreds of people have been killed in a wave of bombings in India in recent years, mostly blamed on Muslim militants, with targets ranging from mosques and Hindu temples to trains.

Saturday's explosion comes days after a series of bombs in the capital that killed 23 people and wounded more than 100 others. Those attacks had put New Delhi on alert and police were raiding Muslims' quarters and criminal hideouts.

They shot dead two Muslims in a raid last week, saying one of them was the mastermind of the New Delhi bombings.

The failure to prevent such attacks has become an embarrassment for the Congress party-led coalition government, with elections less than a year away.

"The government will have to take stern measures to put an end to this type of activities and acts of terror," Foreign Minister Pranab Mukherjee told reporters.

In July, at least 45 people were killed when a series of bombs ripped through Ahmedabad, the main city of the western state of Gujarat. A day earlier, one woman died when eight bombs went off in the IT hub of Bangalore.

In May, more than 50 people were killed in coordinated bomb attacks in the western tourist city of Jaipur.

Police have blamed the banned Students' Islamic Movement of India for most attacks in recent years, but say that local Muslims appear to have been given training and backing by militant groups in neighbouring Pakistan and Bangladesh. (Additional reporting by Mark Williams; Writing by Krittivas Mukherjee; Editing by Giles Elgood)

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