The Indians, who did well to restrict Sri Lanka to a modest 228-9 from 50 overs, collapsed under the lights at the Premadasa stadium to be shut out at 203-9.
Sachin Tendulkar was the lone top-order batsman to defy the Sri Lankans, making a spirited 74 after a 10-over spell of tidy leg-spin which fetched him two wickets for 40 runs.
The ninth-wicket pair of Harbhajan Singh and Zaheer Khan put on the highest stand of the innings of 46, but the effort came too late to deny Sri Lanka victory.
Harbhajan made 16, while Zaheer hit two towering sixes off Muttiah Muralitharan in his unbeaten 29 off 24 balls.
Sri Lankan leg-spinner Upul Chandana demolished India's batting on the dry, slow surface with the wickets of vice-captain Rahul Dravid, Yuvraj Singh and Mohammad Kaif. Sanath Jayasuriya claimed two for 34.
It was India's 10th defeat in their last 13 one-day finals with the lone victory coming in the NatWest Trophy against hosts England at Lord's in 2002. Two matches were rained off.
India, who needed 4.58 runs an over to win, made a disastrous start when they lost Virender Sehwag and captain Sourav Ganguly by the eighth over with the total at 26.
Sehwag was trapped leg-before by Chaminda Vaas for five, while Ganguly was superbly caught in the slips by a diving Mahela Jayawardena off Nuwan Zoysa.
Venkatsai Laxman, returning from a knee injury, helped Tendulkar take the score to 62 when he mistimed a drive off Jayasuriya to short mid-off.
India slid further to 96-4 in the 27th over when Dravid edged Chandana to Tillekeratne Dilshan at first slip, who juggled with the ball before taking the catch.
Chandana struck again in the 35th when he clean bowled Yuvraj Singh, who managed only eight runs in his 100th one-dayer.
Mohammad Kaif holed out in the deep off Chandana after making five, before Tendulkar himself departed.
Having hit seven boundaries and a six, Tendulkar was seventh out when he was bowled by Dilshan. It was just reward for the off-spinner who had two close appeals for leg-before turned down by New Zealand umpire Billy Bowden.
In the first session, the part-time spin of Sehwag and Tendulkar dried up Sri Lanka's runs after Marvan Atapattu won the toss and elected to bat.
Sehwag chipped in with 1-32 from 10 overs of off-spin, while young left-arm seamer Irfan Pathan finished with 2-33 to emerge the most successful bowler in the tournament with 14 wickets.
Atapattu top-scored with 65, adding 116 for the third wicket with Kumar Sangakkara (53) to steady the innings that was rocking at 31-2 in the eighth over.
But 32 extras was the next highest contributor as the Indians sent down 11 wides and three no-balls.
SCOREBOARD
SRI LANKA:
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A. Gunawardena c Ganguly b Nehra 8
S. Jayasuriya lbw b Pathan 15
M. Atapattu run out 65
K. Sangakkara b Sehwag 53
M. Jayawardena c Yuvraj b Tendulkar 0
T. Dilshan st Dravid b Tendulkar 22
U. Chandana lbw b Harbhajan 8
F. Maharoof run out 9
C. Vaas c Yuvraj b Pathan 6
N. Zoysa not out 6
M. Muralitharan not out 4
Extras: (b4, lb14, w11, nb3) 32
Total (for nine wickets) 228
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Fall of wickets: 1-28, 2-31, 3-147, 4-150, 5-174, 6-194, 7-202, 8-213, 9-219
Bowling: Pathan 7-0-33-2, Nehra 6-0-22-1, Zaheer 7-0-35-0, Harbhajan 10-0-48-1, Sehwag 10-2-32-1, Tendulkar 10-0-40-2
Overs: 50
INDIA:
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V. Sehwag lbw b Vaas 5
S. Tendulkar b Dilshan 74
S. Ganguly c Jayawardena b Zoysa 4
V. Laxman c Dilshan b Jayasuriya 12
R. Dravid c Dilshan b Chandana 16
Y. Singh b Chandana 8
Mohammad Kaif c Jayawardena b Chandana 5
Irfan Pathan run out 2
H. Singh st Sangakkara b Jayasuriya 16
Zaheer Khan not out 29
A. Nehra not out 7
Extras: (b12, lb8, w3, nb2) 25
Total (for nine wickets) 203
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Fall of wickets: 1-15, 2-26, 3-62, 4-96, 5-119, 6-135, 7-140, 8-147
Bowling: Vaas 7-1-24-1, Zoysa 8-2-18-1, Maharoof 2-0-16-0, Muralitharan 9-0-46-0, Jayasuriya 10-0-34-2, Chandana 10-0-33-3, Dilshan 4-0-12-1
Overs: 50
Result: Sri Lanka won by 25 runs
Toss: Sri Lanka
Umpires: David Shepherd (ENG) and Billy Bowden (NZL)
Match referee: Mike Procter (RSA)