In a closely-fought final, India took the lead in the 31st minute with Holicharan Nazary converting a penalty kick but Nepal replied strongly in the second half by pumping in two goals through Prakash Thapa (66th) and Nawayug Shreshtha (72nd) to win the match at the Indira Gandhi Stadium.
India thus settled for the silver while Bangladesh took the bronze after defeating Maldives 7-6 via penalty shoot-out in the third-place play-off today.
In 2004, India had lost to Pakistan in the final in Islamabad. In 2006 and 2010, they had not reached the final.
The match began on an even keel with India getting some fine goal-bound moves with striker Udanta Singh putting pressure on the opposition defence.
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From one such attacking move, India earned a spot kick after Udanta was fouled by Ananta Tamang in the 31st minute and Holicharan stepped up to convert it and put the home side 1-0 up.
In the 66th minute, they got a free-kick and Prakash Thapa curled it to the left of the Indian goalkeeper with the home side defensive wall rooted at the ground to stun the home crowd, which also had Games Chairman and Union Sports Minister Sarbananda Sonowal among them.
India were also saved from conceding another goal in the 69th minute with central defender Sandesh Jhingan clearing the ball from goal-line after the home team custodian was beaten.
India could have equalised quickly but Mawihmingthanga's shot in the 74th minute from close range was palmed away by the Nepalese goalkeeper.
Five minutes later, Rowlin Borges' header in front of an empty Nepal goal went over the bar.