"They are with us in Slaviansk," the de facto mayor of the city, Vyacheslav Ponomaryov, told Reuters in front of the seized security service building where, according to the Ukrainian government, the observers were being held.
"What the situation was I do not know," he said. "It was reported to me that among them (the observers) was an employee of Kiev's secret military staff."
"People who come here as observers bringing with them a real spy: it's not appropriate." Later, a man in a mask and camouflage fatigues said there would be no more comments on Friday evening.
The detention of the observers, who are working for the Vienna-based Organization for Security and Cooperation in Europe (OSCE) will heighten Western concerns about lawlessness and arbitrary rule in separatist-held parts of eastern Ukraine.
It may also increase Western leaders' pressure on Moscow, which they accuse of backing the militias. The Kremlin denies interfering in eastern Ukraine.
Swedish Foreign Minister Carl Bildt wrote on his Twitter account: "Extremely concerned with OSCE inspectors being abducted in Eastern Ukraine. Including one Swede. They must be released immediately."
Slaviansk is the biggest flashpoint in an armed uprising in eastern Ukraine that has widened into the worst stand-off between Russia and the West since the end of the Cold War.
German Defence Minister Ursula von der Leyen said 13 OSCE observers had been seized, including three members of the German armed forces, a German translator and a Danish national. The German foreign ministry said earlier the group included military observers from the Czech Republic, Poland, Sweden and Denmark.
"It is critical that we use all diplomatic channels to free this team immediately and unhurt," von der Leyen said. "But at the moment we are still in a situation where we are gathering information and trying to find out what it is that those who seized them are demanding."
The interior ministry in Kiev said the group that had been detained included seven OSCE representatives and five members of the Ukrainian armed forces who were accompanying them.
"At the moment, talks are going on with representatives of pro-Russian forces. They have refused to free the hostages, saying they want to speak to "competent organs" of the Russian Federation," the Ukrainian interior ministry spokesman said.
Slaviansk, a city of around 130,000, has been for two weeks under the control of separatists who, like similar groups elsewhere in eastern Ukraine, oppose the central government in Kiev after the overthrow of a Kremlin-backed president.
Government forces said on Friday that they were gradually tightening a blockade on the city in an "anti-terrorist operation" that was relaunched earlier this week.
The separatists there have also been holding several journalists, although they released one of them, a U.S. citizen, on Thursday.
Russia says the pro-Russian militias are a spontaneous protest against a government in Kiev which it says is illegitimate, has far-right links, and has committed a crime by using the army to put down the revolt.
Several of the separatists manning checkpoints on the edge of the city have been killed in raids by defence and interior ministry forces from the Western-backed government in Kiev.
