"Kashmir is the central issue that awaits just and durable settlement," he added.
The President said: "This is a moment of hope and optimism. Let us nurture it carefully and make the process of engagement (between Pakistan and India) irreversible," he said.
The President was speaking on the theme of future of Pakistan-India relations while addressing the 'India Today Conclave' via satellite from Islamabad.
"India and Pakistan must bury the past and chart a new roadmap for peace," the President said, adding that peoples of the two countries desired peace and were fed up of confrontation.
Referring to the checkered history of the two countries, he said Pakistan and India have lost half a century in mutual squabbles.
"Lets face it," he said and recalled the two countries had fought wars, tested nuclear weapons and have remained engaged in hot confrontation making the region "most dangerous flash points in the world".
He said at the centre of this is the spiralling vortex of Pakistan-India animosity that has bedevilled their ties for over half a century.
"If Pakistan and India could settle Kashmir in accordance with the aspirations of Kashmiris, a new chapter in our troubled history could begin."
This, he said, was only possible if all parties were sincere in their quest for a just and durable peace through a solution acceptable to all.
President Musharraf said he would not speak about the political and legal history of Kashmir as it was well recorded and documented in the archives and resolutions of the United Nations.
Emphasising the centrality of the Kashmir dispute, Musharraf said: "Let's be pragmatic. Let us learn to accept hard facts and resolve it (Kashmir issue) in an equitable and honourable manner acceptable to India, Pakistan and Kashmiris."
He alluded to his four-point process whereby talks commence; centrality of Kashmir dispute is accepted; all solutions not acceptable to either of the three parties are taken off the table and of the remaining option the one deemed most feasible and acceptable is chosen. "I believe nothing could be fairer than that."
The President said a solution will emerge if all sides were mindful of the problem, "if all parties, specially Kashmiris, are given the opportunity to have their due say and are associated with a credible, sincere and serious quest for a final settlement between Pakistan and India".
The President said that the joint statement reached at Islamabad provided a good framework for a relationship of harmony and mutual respect.
He said the confidence-building measures (CBMs), already initiated, have generated tremendous goodwill, adding, foreign secretary-level talks have further inched the dialogue process forward.
"The composite dialogue scheduled for May/June this year should augur well for our future relationship," he said.
However, the President cautioned: "There is a simultaneity/linkage between CBMs and the composite dialogue. CBMs cannot outstrip the dialogue process on all substantive issues including Kashmir."
The President reiterated that "Kashmir dispute can never be sidelined or ignored" and stressed the two countries "must move forward towards its resolution in tandem with the CBMs."
He underlined that "sooner or later Kashmiris must join the peace process on Kashmir to make a solution practicable."
The President, however, cautioned about the extremists on both sides who, he said, would try to derail the process.
"We must not be deterred from our path and be prepared to deal with them with an iron hand. In fact, in our own supreme interests, we must negotiate peace boldly as if there are no detracting extremists, and we must also deal with all extremists firmly as if there is no peace initiative."
He assured that Pakistan was determined "to take two steps forward if India takes one step and chooses to embark on a realistic quest for a just and durable peace with Pakistan on the basis of sovereign equality."
He said India will find Pakistan sincere and responsive, if it desires genuine improvement in relations.
"We are mindful of the difficulties posed by rigid mindsets. We must persevere.
But, he warned, if there was no movement towards a solution, everything would slide back to square one.
President Musharraf listed a number of benefits, which the two countries would have once there is peace in the region.
He said the market size will expand to 1.2 billion (equal to that of China) opening vistas of trading opportunities within the region.
The foreign direct investment presently stagnating at $ 3 billion could increase manifold. The natural gas from Iran and Central Asia can become available to the region bringing down energy costs by at least 50 percent. India may be the maximum gainer.
He said the region has a vast treasure of tourist attractions and the two countries could benefit from combined regional tours.
President Musharraf said with the reduction in defence expenditure, funds would be made available for social sectors and poverty reduction.
Through mutual sports, India and Pakistan could regain the lost glory in hockey and cricket.
He said progress on dialogue towards serious resolution of disputes should set us thinking on other more substantive CBMs.
"Why can't our defence expenditure be cut down? It certainly can. Pakistan is not in an arms race. We maintain a quantified force level based on a perceived threat, and a strategy of minimum deterrence.
President Musharraf said: "With the enhancement of firepower of weapons, we are already reducing the strength of our army by 50,000. We had kept our defence budget frozen for the past 4 years.
India has to review its own strategy because your defence force levels are not based on threat but on power projection."
He also pointed at the latest multi-billion dollar acquisitions by India and noted the vastly enhanced budgetary allocations to defence.
The President, however, said: "In any case, Pakistan will remain amenable for mutual, proportional reduction of forces."
He said the present time is ideal for resolution of all disputes and ushering in an era of peace, harmony and prosperity. "The peoples of our countries want it, the influential business community is eagerly looking forward to it, the media favours it."
He said the leaders on both sides have to be sincere to develop confidence and trust in each other.
"They have to be flexible enough to reach mutually acceptable solutions to previously intractable disputes and bold enough to bulldoze all opposition and risks en-route to peace."
President Musharraf said: "We have to show enough maturity to be able to resolve disputes bilaterally within a reasonable time line."
He said: "It is only our failure which then invites third party mediation, facilitation, involvement or encouragement. The US being the sole superpower in a uni-polar world has a responsibility for bringing a just peace for our future generations. Their involvement towards resolution of the thorny Kashmir dispute can be of value if we get stuck ourselves".