10 September 2011 Last updated at 14:30 GMT
The MV Spice Islander was travelling between Zanzibar's main island, Unguja, and Pemba, the archipelago's other main island - popular tourist destinations.
Rescue efforts were hampered by the fact that the overloaded boat had capsized at night.
It had been bringing people back from holiday after Ramadan, and had reportedly stopped earlier in Tanzania's commercial capital, Dar es Salaam.
The authorities are struggling to cope and have asked for foreign help.
"We have recovered 163 people who have died and we have rescued 325 survivors," regional emergencies minister Mohammed Aboud told the AFP news agency.
The Zanzibar government has set up a rescue centre and called upon all reserves to join the rescue effort. It has also called for support from other countries, such as South Africa and Kenya.
Washed ashore The survivors were ferried by privately owned fast ferries and brought back to the main harbour in the historic Stone Town, Zanzibar police commissioner Mussar Hamis said.
"We are still receiving many bodies by truck loads," Dr Karim Zah of the Mnazi Mmoja Hospital in Zanzibar told Reuters news agency.
Those rescued were brought back to the main harbour in Stone Town "The death toll will likely be much higher."
Dozens of soldiers carrying bodies to shore dotted the white sand beaches at the northern tip of Zanzibar island where thousands of people anxiously awaited news of survivors, the agency adds.
Catherine Purvis, a British tourist in Zanzibar who was waiting for a ferry to take her to Dar es Salaam, says she saw lots of bodies being brought out of the water.
"I'm standing at the port in Zanzibar with about 10 other British and American tourists," she said.
"Our ferry has been delayed as they're using all ferries to rescue the people from the ship.
"People are being carried across in front of us on a drip. There are lots of body bags."
The regional emergencies minister said 40 of those rescued had been seriously injured.
Holding on Local helicopter pilot Captain Neels van Eijk flew over the disaster area.
"We found the survivors holding on to mattresses and fridges and anything that could float," he told the BBC.
"By then, there were a few boats that had made their way out. They were looking for survivors, but although the sea wasn't so rough, the waves were high so it was difficult for them to spot them.
"We flew to the boats and guided them to the survivors so that they could pick them up. There were also quite a few bodies in the water."
The ferry left Unguja at around 21:00 (19:00 GMT) and is said to have sunk at around 01:00 (23:00 GMT).
One survivor, Abdullah Saied, said the ferry had been heavily overloaded when it left Dar es Salaam, and some passengers there had refused to board, the Associated Press news agency reports.
Zanzibar ferry disaster: Scores die, many more missing
Captain Neels Van Eljk, whose boat came to rescue passengers, said survivors were clinging to whatever they could find
At least 163 people have died after an overloaded ferry sank off the Tanzanian island of Zanzibar with at least 600 people on board.
Zanzibar's emergencies minister said 325 survivors had been rescued so far. The MV Spice Islander was travelling between Zanzibar's main island, Unguja, and Pemba, the archipelago's other main island - popular tourist destinations.
Rescue efforts were hampered by the fact that the overloaded boat had capsized at night.
It had been bringing people back from holiday after Ramadan, and had reportedly stopped earlier in Tanzania's commercial capital, Dar es Salaam.
The authorities are struggling to cope and have asked for foreign help.
"We have recovered 163 people who have died and we have rescued 325 survivors," regional emergencies minister Mohammed Aboud told the AFP news agency.
The Zanzibar government has set up a rescue centre and called upon all reserves to join the rescue effort. It has also called for support from other countries, such as South Africa and Kenya.
Washed ashore The survivors were ferried by privately owned fast ferries and brought back to the main harbour in the historic Stone Town, Zanzibar police commissioner Mussar Hamis said.
"We are still receiving many bodies by truck loads," Dr Karim Zah of the Mnazi Mmoja Hospital in Zanzibar told Reuters news agency.
Those rescued were brought back to the main harbour in Stone Town Dozens of soldiers carrying bodies to shore dotted the white sand beaches at the northern tip of Zanzibar island where thousands of people anxiously awaited news of survivors, the agency adds.
Catherine Purvis, a British tourist in Zanzibar who was waiting for a ferry to take her to Dar es Salaam, says she saw lots of bodies being brought out of the water.
"I'm standing at the port in Zanzibar with about 10 other British and American tourists," she said.
"Our ferry has been delayed as they're using all ferries to rescue the people from the ship.
"People are being carried across in front of us on a drip. There are lots of body bags."
The regional emergencies minister said 40 of those rescued had been seriously injured.
Holding on Local helicopter pilot Captain Neels van Eijk flew over the disaster area.
"We found the survivors holding on to mattresses and fridges and anything that could float," he told the BBC.
"We flew to the boats and guided them to the survivors so that they could pick them up. There were also quite a few bodies in the water."
The ferry left Unguja at around 21:00 (19:00 GMT) and is said to have sunk at around 01:00 (23:00 GMT).
One survivor, Abdullah Saied, said the ferry had been heavily overloaded when it left Dar es Salaam, and some passengers there had refused to board, the Associated Press news agency reports.
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