Provincial Governor Mohammad Ali Karimi said at least 420 people had been killed and 900 injured, in the quake that measured 6.4 on the Richter scale, adding that the authorities feared the toll could increase further.
Most of the dead were in the Zarand region north of the provincial capital of Kerman.
Villagers scrambled to pull bodies from the rubble of their houses, wailing in distress amid roads strewn with debris.
Karimi said 40 villages, which are home to more than 30,000 residents, were affected. Half of them, including Dahuyeh, which has a population of 820, were flattened, said the Iranian Red Crescent.
Villagers were buried alive in Dahuyeh's mosque when the quake struck during pre-dawn prayers, natural disaster services official Mohammad Javad Fadaie told state media.
Only the green dome of the Sultan Seyed Ibrahim mausoleum was left standing.
Several hours later, men were seen desperately overturning rubble brick by brick to search for survivors.
Others who had miraculously escaped when their simple mud-brick homes collapsed sat among the debris, ankle deep in mud, wrapped in blankets handed out by dozens of rescue workers, soldiers and volunteers.
The governor said the rescue effort was completed by early afternoon in most of the affected area, apart from three or four remote villages where rescuers feared the worst. "We think the death toll will climb to more than 500... once we have gained access to the villages" with the use of helicopters, Iraj Sharifi head of the Kerman University Hospitals told AFP.
But hospitals in Zarand, even if overwhelmed by the number of injured, were not damaged and local infrastructure remained intact, he said.
Officials said the good fortune and lessons learned from the Bam temblor had made relief efforts more effective.
The US Geological Survey said the earthquake struck at 5:55am with its epicenter located some 60 kilometers north-west of the city of Kerman.
An interior ministry spokesman, Jahanbakhsh Khanjani, said it took "just seconds" before emergency services were rushed to the scene.
Governor Karimi said the authorities had learnt from the Bam experience, when they came in for criticism, and that this time the Islamic republic would not need international aid.
Sharifi told AFP that "compared to Bam's earthquake, Kerman's was completely different.
"Since we had that experience before, the relief and supports were sorted out by local teams, each taking action as small disaster committees only half an hour after the incident. "If the main cities had been damaged, we might not be able to deal with the disaster so quickly," Sharifi added.
Neighbouring Turkey, which like Iran has long experience of deadly earthquakes, offered to provide aid but was turned down, Turkish Prime Minister Recep Tayyip Erdogan said.
President Pervez Musharraf also offered aid. Several helicopters were sent to the scene, and the government also mobilised two battalions of troops to help in the rescue effort, while residents were urged to stay outdoors amid some 20 aftershocks.
There were no reports of casualties in the city of Kerman, but the quake had knocked out electrical power in the provincial capital.