How to draw a cursor on terrain?

I want to display a cursor on my terrain. Similar to Baldur's Gate. Any idea how to do this?

I would experiment with the Projector feature:

In the above link they illustrate how to render a fake blob shadow. You should be able project the mouse coordinates into 3D space to control the positioning of the projector on the terrain. Instead of a shadow texture, you would use whatever texture you want to represent your cursor.