Tried to come out of reality and experimented with Escher's Droste Effect. Initially I worked on a different image which included a composite of 4 pictures but the result looked very unconvincing, so threw it away and tried a simple image.
Done with Gimp and Mathmap plugin. Thanks to Josh for sending code and tutorial. This guy is doing lot of Escher's stuff.
Getting this effect itself is quite simple. To find out how, try this link. First you need a transparent region on the image which you want to fill out recursively. For above picture, I made the base of mug transparent. Then the rest you need is the Mathmap Gimp plugin and the code that you can paste into it for carrying out distortion.