The home side were beaten 15-13, 8-15, 6-15, 3-15 at the Indira Gandhi Sports Complex but still will walk away with a maiden bronze. Under ISTAF (international federation) rules, both the semifinalists will get a bronze each.
Backed by a cheering home crowd, the fourth seed Indians began confidently winning the first set despite star striker Akash Singh looking a little subdued compared to his Malaysian counterpart Norshahruddin Mad Ghani.
In the second set, India matched Malaysia point for point early on, but fell back after 4-4 to allow their second seed opponents to win the set.
"This is the first time in Indian sepaktakraw history that we've managed to take a set off Malaysia," said coach Hemraj.
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"We played well, but more than that, we had a fine run in the tournament and I'm very pleased with our overall performance," he said after the match.
Hemraj used the same team as he had from Day One, with Akash, Sandeep Kumar and G Jiteshor Sharma defeating Singapore twice in their group matches and Iran in the quarter-final to reach the last four.
Men's semi-final: Malaysia bt India 3-1 (13-15, 15-8, 15-6, 15-3); South Korea bt Indonesia 3-0 (15-13, 16-14, 15-9)
5/6 placing - Thailand bt Iran 3-0 (15-5, 15-4, 15-4)
7/8 placing - Japan by Singapore 3-1 (14-16, 15-8, 15-8, 15-12)
9/10 placing - Brunei bt the United States 3-2 (8-15, 15-10, 15-11, 6-15, 12-15)
Women's: 5/7 placing - South Korea bt India 3-0 (15-5, 15-9, 15-6); Japan bt India 3-1 (14-16, 12-15, 13-15, 13-15).