Stephen Fitzpatrick, Dili – Thousands of East Timorese were pouring into makeshift refugee camps in Dili last night, fearful of being murdered in an outbreak of ethnic violence.

Homes in the capital have been torched and a marketplace razed over the weekend, bandit gangs organised on ethnic lines are patrolling the roads to towns beyond Dili, and many ordinary Timorese are being forced to identify neighbours to be attacked or killed.

Many who have lost their homes are sheltering in refugee camps such as the Dom Bosco seminary, which last housed masses of frightened East Timorese during the 1999 post-referendum massacres.

Others in the wave of frightened people heading for shelter last night included those who refused to take part in attacks, making themselves targets.

Five people are believed dead in the violence, the worst since East Timor won independence from Indonesia in 1999. More than 40 people were being treated in Dili's main hospital yesterday for injuries stemming from machete and bullet wounds. Other victims had been hit by stones and arrows, said doctor Antonio Caleres.

At Dom Bosco, principal brother Adriano de Jesus said yesterday that 1500 families had gathered on Friday afternoon.

"I myself just saw another 30 families arrive," he said. "Last night the football field was full of people, none of whom believed they were safe at home.

"We have here several families from Liquica (an outlying town) who came for market on Friday, leaving infant children at home. They cannot return now because there is a danger gangs on the road will kill them. I've tried to organise security to get them home, but the police say it is not safe to travel."

One man said he had brought his family of 15 to the shelter after a demonstration on Friday turned ugly and spread to other parts of the dusty port city, with up to five people dead. "There was shooting, and I was afraid my family would be hit," he said.

Aid groups are providing food, medicines, portable toilets and food and water for the refugees.

The latest violence began with a series of protests over the perceived ill-treatment of a group of almost 600 soldiers from the tiny nation's western-based ethnic group, sacked after going on strike over claims they had missed out on promotion in favour of soldiers from the east.

Discontent built in Friday's heat to a murderous campaign of savagery, with angry supporters of the deserting soldiers attacking the office of Prime Minister Mari Alkatiri after a 3pm deadline for the Government to respond to their grievances passed without action. The building's windows were smashed and a number of vehicles torched.

Demonstrators allege troops opened fire, first with tear gas and then with live rounds, when the crowd showed signs of heading towards the town's shopping district. Two people are thought to have been killed in that episode.

In the nearby Taibesi market area, the ethnic tensions took on an equally deadly turn when a fist-fight between two men from the country's two main ethnic divisions – Lorosae, or easterners, and Loromonu, westerners – degenerated into a brawl that ended with at least one man shot in the head and the easterners' section of the market destroyed.

President Xanana Gusmao met late yesterday with Dr Alkatiri, Foreign Minister Jose Ramos Horta, police chief Paulo Martins and army commander Brigadier-General Taur Matan Ruak to discuss the crisis.

Foreign Minister Alexander Downer urged Australians who were in East Timor, or thinking of going to the country, to exercise the highest degree of caution.

"As for the cause of the riots, we are still investigating that," he said. "There have been about 590 members of the East Timorese army who have been dismissed from the army, and those people have been demonstrating from time to time against the East Timor Government.

"But there's some evidence... that these riots weren't triggered by those people, as is popularly believed. But we're continuing to monitor the situation.

"There is no plan for Australia to become any more involved, and the East Timorese haven't asked us to become involved in any way at all by sending any reinforcements to them – they feel confident they can handle the situation on their own."

One villager said the violence in Taibesi was the result of frustration that East Timor's struggling administration had failed to provide an adequate standard of living or protect its citizens and that the dispute over the soldiers' treatment was the spark for the chaos.

"Send back the UN to run the country and provide security," Antonio Castro demanded. "The market was torched because our Government has failed to live up to its responsibilities, so the youth took matters into their own hands."

Dr Alkatiri made an address on national radio and TV last night appealing for calm, but Brother de Jesus said he was worried violence would flare up again. "Yesterday I brought one of the military deserters here and he had been shot," Brother de Jesus said. "He told me: 'I am a victim in this.' He himself had been shot by the military."

Most witnesses say few of the deserting soldiers have been involved in recent events – they have largely taken to the hills, says one, "where they are now being hunted like wild animals".