Senior Congress party leader Rahul Gandhi and several government ministers from the state of Punjab were among the large crowd attending the state funeral in Singh's home village.
Singh, sentenced to death by Pakistan in 1991, died after being attacked with bricks by inmates in Lahore's jail.
Delhi called the attack "barbaric".
Indian PM Manmohan Singh has demanded that the perpetrators be brought to justice.
Sarabjit Singh had been convicted of spying and over his role in bomb attacks that killed 14 people in Pakistan in 1990.
By Ravinder  Singh RobinJournalist
A 21-gun salute was fired as thousands of mourners gathered at the cremation ground in Bhikhiwind village, in Punjab's Tarn Taran district.
Sarabjit Singh's sister, Dalbir Kaur, who had campaigned relentlessly for years to get her brother freed, lit the funeral pyre with help from a local politician.
Singh's coffin was carried through village streets lined with thousands of spectators, before reaching the cremation ground. Thousands of policemen were deployed to ensure security. All roads leading to the small village on the India-Pakistan border were jammed with people trying to get to the venue.
Earlier, Singh's body was kept in a local school where thousands of people visited since early on Friday to pay their respects. His coffin was kept on a platform, draped in the national flag, and visitors were seen putting flowers on his body.
His wife, daughters and sister sat nearby, mourning, while some of the visitors raised slogans of "Long live Sarabjit" and "Death to Pakistan".
His family always insisted he was innocent and had strayed into Pakistan by mistake when he was arrested.
The issue risks stirring fresh tensions between the nuclear-armed neighbours and long-time rivals, correspondents say.
Meanwhile a Pakistani prisoner, Sanaullah Haq, suffered critical head injuries after he was attacked by a fellow inmate at the high-security Kot Bhalwal jail in Jammu, in Indian-administered Kashmir.
He has been admitted to intensive care at a Jammu hospital and doctors say he is in a coma.
Police say Haq has been in prison for the past 17 years on militancy-related charges.
His attacker, police say, is a former Indian army soldier convicted of murder. Reports said the attack happened on Friday morning after an argument between the two men.
Pakistan's government issued a statement expressing "deep concern" over the attack and saying it had sought "immediate consular access" to Haq.
The attack was "obvious retaliation" for the killing of Sarabjit Singh, it added.
The body of 49-year-old Sarabjit Singh was flown to Amritsar, northern India, from Lahore on Thursday.
Hundreds of mourners waited at the airport, describing Sarabjit Singh as a "martyr".
His death triggered protests in India, as people burned Pakistani flags and accused Islamabad of a conspiracy to kill him.
By Soutik BiswasIndia correspondent
His body was handed over to his family in the village of Bhikhiwind for Friday's cremation.
In a statement, Manmohan Singh called Sarabjit Singh "a brave son of India" and said the attack was "barbaric".
"It is particularly regrettable that the government of Pakistan did not heed the pleas of the government of India, Sarabjit's family and of civil society in India and Pakistan to take a humanitarian view of this case," he added.
He was referring to mercy petitions which had been rejected by Pakistani courts and former President Pervez Musharraf.
Sarabjit Singh's sister Dalbir Kaur called her brother's death "a murder by Pakistan".
Ms Kaur said she would continue to fight for the release of other Indian prisoners in Pakistani jails.
Meanwhile, the government in Punjab has declared a three-day state mourning and the Punjab assembly has unanimously passed a resolution declaring Sarabjit Singh a "national martyr".
Sarabjit Singh fell into a coma after last Friday's attack in Lahore's Jinnah hospital and died on Thursday morning.
He was assaulted as he and other prisoners were brought out of their cells for a one-hour break.
Obituary: Sarabjit Singh
Two inmates have been charged over the attack and two officials suspended.
The Pakistani foreign ministry said Sarabjit Singh had received "the best treatment available" and that "medical staff at Jinnah Hospital had been working round the clock... to save his life".
But a Pakistani intelligence official criticised India for the honour given to Singh, saying he had been involved in bomb attacks in Pakistan and should not be treated as a hero in his homeland.
Tensions between the two countries had already increased in the past six months with the execution in India of Kashmiri Afzul Guru over the 2001 attack on India's parliament, and of Mohammed Ajmal Qasab, a Pakistani who was the sole surviving gunman from the 2008 Mumbai attacks.
Sarabjit Singh's lawyer Owais Sheikh said his client had received threats after Guru's execution.
Pakistan and India frequently arrest each other's citizens, often accusing them of being spies after they have strayed across the land or maritime border.
In recent years, several Indians returning from Pakistani jails have admitted to spying.
Sarabjit Singh, the Indian convicted of spying in Pakistan and killed in a Pakistani jail last week, has been cremated in India amid mass outrage.