Firework use hits a peak across India during the festival, although the Supreme Court has been trying to restrict sales to tackle mounting pollution.
The explosion in Badaun district of Uttar Pradesh destroyed the factory which had a license to manufacture firecrackers, the district police chief said.
"There was an explosion at the factory. We have confirmation of about seven deaths," Ashok Kumar told reporters, adding that fire brigade and ambulance services were carrying out rescue operations.
Diwali is traditionally celebrated by lighting lamps but has since metamorphosed into a grand show of fireworks, sparking pollution fears.
Explosions often occur in illegal backyard and underground workshops producing firecrackers for Diwali.
Last year seven workers were killed in an explosion at an illegal factory in the eastern state of Odisha.
The Supreme Court on Tuesday ordered that only reduced smoke fireworks -- so-called "green firecrackers" -- could be sold and that all sales must be through licensed traders.
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