Lee Gyeong-Og, the vice minister of security and public administration, told a press briefing in Seoul that he could only confirm the rescue of 161 people so far.
However, he added that commercial ships involved in the operation were understood to have rescued a significant number of people.
"The ferry is almost completely submerged," Lee said, adding that a detachment of South Korean Navy SEALS were taking part in the rescue.
Lee had said there were no reports of casualties so far, but the coastguard later said one person had been killed.
"We have recovered one body from the ship so far," a spokesman told AFP.
Photos broadcast on television showed the ship initially tilted over 45 degrees on the port side with helicopters flying overhead, and then fully capsized with only its stern visible.
Of the 450 passengers on board the ferry bound for the southern resort island of Jeju, 325 were students from a high school in Ansan, south of Seoul. The remainder of those on board were crew.
Coastguard officials said the crew sent out a distress signal at 9:00 am (0000 GMT) with passenger testimony suggesting it may have run aground.
"We heard a big thumping sound and the boat stopped," one passenger told the YTN news channel by telephone.
The 6,825-tonne ferry, which had sailed out of the western port of Incheon on Tuesday evening, ran into trouble some 20 kilometres (13 miles) off the island of Byungpoong.
Distraught parents of the students gathered at the high school in Ansan, desperate for news.
TV footage showed a chaotic scene in the school's auditorium, with parents yelling at school officials and frantically trying to make phone calls to their children.
"I talked to my daughter. She said she had been rescued along with 10 other students," one mother told the YTN news channel.
"They said they had jumped into the water before getting rescued. One was injured in the leg and is being treated in hospital," she said.
Lee Gyeong-Og said 34 naval, coastguard and civilian vessels were involved in the rescue operation, along with 18 helicopters.
In a personal message, President Park Geun-Hye "ordered us to make efforts not to leave a single casualty," he said.
The ferry manifest included 150 cars.
Hundreds of ferries ply the waters between the South Korean mainland and its multiple offshore islands every day, and accidents are relatively rare.
However in one of the worst incidents, nearly 300 people died when a ferry capsized off the western coast in October, 1993.
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