Erismar Rodrigues Moreira, known as Bem-te-vi, was shot to death during an anti-drug raid on the Rocinha shantytown, said Ricardo Gouveia, a spokesman with Rio's public safety secretariat.
More than 150 police officers entered the shantytown Friday evening to arrest Moreira and members of his gang, police said. The gunfight began early Saturday morning, lasting nearly two hours.
Moreira, accompanied by nearly 20 heavily armed men at the time of the shooting, died of gunshot wounds to the head and chest, police said. The confrontation also left another gang member dead and at least three Rocinha residents injured.
It wasn't immediately clear how many gang members were arrested.
The operation, dubbed "Troy," had been planned for three weeks with intelligence from several undercover officers living at Rocinha, police said.
Another shooting broke out at Rocinha on Saturday afternoon, despite the presence of about 30 officers who stayed behind to prevent other confrontations between gangs battling for control of drug-selling spots.
"The operation will continue," Rio de Janeiro State Security Secretary Marcelo Itagiba told the government news service Agencia Brasil. "Arresting criminals is a job that never ends."
Authorities said the later fighting was likely between gang members in Rocinha and the neighboring Vidigal shantytown a turf war between gangs from the two neighborhoods has left nearly 30 people dead this year alone.
The gunfight forced police to block traffic on nearby streets for nearly one hour, but there were no reports of injuries.
Police said Moreira allegedly controlled drug traffic on the hills of Rocinha since April 2004, when police killed former drug boss Luciano Barbosa da Silva, better known as Lulu.
In July, Moreira shut down a major tunnel in Rio after police killed one of his gang members during the drug lord's birthday celebration in the shantytown.
The Rocinha shantytown, perched on the hills overlooking some of Rio's richest neighborhoods and most famous beaches, is a cocaine vending point for the city's well-off residents.
Rio is one of the most violent cities in the world with a homicide rate of around 50 per 100,000. Most of the violence is confined to the shantytowns and the city's poor north side, repoted AP.
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