Australia suspended vice-captain Watson and three other stars - among them star bowler Mitchell Johnson - for failing to complete a written exercise after their humiliating Test defeat by India.
Coach Mickey Arthur said it was about "drawing a line in the sand" in terms of the team's discipline, though he did add that he had no other problems with Watson.
Yet the all-rounder immediately flew home and made it clear to media that he was furious with his treatment.
"Any time you are suspended from a Test match, unless you have done something unbelievably wrong and obviously everyone knows what those rules are - I think it is very harsh," he said.
"In the end I have got to live with it. That is the decision they have made and at this point in time I am at a stage where I have to weigh up my future with what I want to do with my cricket in general.
"I am going to spend the next few weeks with my family and weigh up my options as to exactly which direction I want to go or keep on.
"I am going to have to sit down and work that out with my family. There are a lot more important things in life. I do love playing cricket and that passion is still there and I feel I am in the prime years of my cricket career."
Watson's wife is currently expecting a baby, and the player had been due to skip the fourth and final Test in any case.
The Aussies were crushed inside three-and-a-half days in an innings defeat in Hyderabad - their second consecutive loss on the tour after being thrashed in Chennai.
That prompted coach Arthur to ask all his players to come up with three ways to improve their own and the team's performance.
All of them either jotted down a few notes or sent Arthur a text - with the exceptions of Watson, Johnson, James Pattinson and Usman Khawaja.
The coach was furious with the quartet for failing to come up with anything - and after talking it through with skipper Michael Clarke, told all four that they would not be considered for selection for the third Test in Mohali.
"It's extremely tough to sit here and make that decision. I wish it wasn't the vice-captain, I wish it wasn't Shane Watson and Mitchell Johnson, they are leaders within the team and are very professional with the way they go about their business.
"But this was a moment where we had to make a statement irrespective of who the players were... As severe as a consequence it is, if we remove the names, it sends a proper statement of what we want to do with this cricket team.
"They are absolutely gutted, as I was having to deliver a message like that," he added. "We were all gutted by it, but this is the expectation if you want to play cricket for Australia."
The decision sparked shock in Australian cricket, with former skipper Allan Border saying: "It seems a bit of a strong measure for a coach or captain to take. I'm surprised that's the penalty for something so mundane. It seems like it was on a schoolboy tour or something. It's an over the top reaction.
"I haven't seen anything quite like this....where you have basically refused to fill out a performance review, it's the first time I've ever heard of it."
Former Test batsman Mark Waugh added: "I'm stunned. I've never heard of this sort of thing before at top level in any sport. It's not under sixes, this is Test cricket...there would have been a better way."
Arthur believed that the homework would help get his faltering team back on track.
"After Hyderabad the whole team was really hurting, we were discussing ways of getting back into the series. We were particularly aware of where we were as a team and how we were going to get back," the coach explained.
"We pride ourselves on attitude. We have given the players a huge amount of latitude to get culture and attitude right. We believe that... teams that are the best in the world have best attitudes and best behaviour patterns and a good, hard, ruthless culture.
"I believe those four players unfortunately did not meet my requirements so those four are not available for selection for this Test match.
"That's a line-in-the-sand moment. We have given these guys absolute clarity. We have given this team a huge amount of time to buy in with what we want to do for the Australian cricket team.
"We have given a vision to these guys that is spelt out. We've given an expectation that is spelt out and although this incident might seem very small in isolation this is a line-in-the-sand moment for us as a unit in our quest to become the best in the world."
Arthur insisted that Watson's future was not in doubt - but he suggested that Khawaja will have a very short Test career if he does not change his attitude following a string of reported lapses.
"I have never ever doubted, not for one moment, the drive of Shane Watson," Arthur said.
"Not for one moment. Shane Watson prepares well. He's very professional and he goes about his business in a very professional way. I've not ever been in a position to doubt Shane Watson the person or Shane Watson the cricketer.
"Usman Khawaja is different. This will be the catalyst I think for Usman Khawaja to realise we're pretty serious in the Australian cricket team."