Watson, Australia's Player of the Year for the last two seasons, sustained an injury in South Africa last month and missed both the series against New Zealand and the Boxing Day Test.
"Shane has not fully recovered from his right calf injury and is therefore not available for the Sydney Test," team physiotherapist Alex Kountouris said.
"He will continue his rehabilitation and hopefully be available for one of the remaining test matches."
Australia, who have never lost a Test series against India on home soil, also play matches in Perth and Adelaide after the Sydney Test.
Squad: Michael Clarke (captain), David Warner, Ed Cowan, Shaun Marsh, Ricky Ponting, Mike Hussey, Brad Haddin, Peter Siddle, Ben Hilfenhaus, Ryan Harris, James Pattinson, Nathan Lyon.
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