This application discloses a packet processing method and an LSR. The method includes: receiving, by an Ingress LSR of a first MPLS tunnel, a first notification packet that is based on an IGP, where the first notification packet includes an ELC flag, which is used to indicate that the first Egress LSR has ELC; after learning from the first notification packet that the first Egress LSR has ELC, inserting a label into a first packet, to generate a second packet, where the label forms an MPLS label stack, which includes, from bottom to top, a first EL, a first ELI, and a first TL; and sending the second packet to the first Egress LSR through the first MPLS tunnel.