Forests are the biggest users of water worldwide and extensive forested areas have been lost or are undergoing conversion to agriculture, creating concerns about loss of hydro logical functions and increasing the competition for scarce water between agriculture, urban centers, industries and wildlife. The challenge is to improve the sustainability and productivity of land and water use, especially for the growing populations of many developing countries. In this chapter we review recent findings on the hydrology of forests and agroforestry systems and indicate how modifications in tree- based systems might increase water productivity. In forestry, the focus of research has moved from the hydro logical functions of upland forest reserves that are close to settlements to a greater recognition of the roles played by upland communi-ties in the management of water resources. A major source of conflict over water resources is the con-trasting perceptions of ‘watershed functions’ between forest managers and local people, which are often based more on myths of forest functions than on science – for example, the idea that forests increase rainfall. These myths continue to dominate the views of policy makers and institutions and should be revised. The challenge is to gain a better insight into how farmer-developed land-use mosaics have modified watershed-protection functions. Priority must be given to the perceptions,experiences and strategies of local communities. Trees on farms have the potential for improving productivity in two ways. Trees can increase the amount of water that is used on farm as tree or crop transpiration. Trees can also increase the produc-tivity of the water that is used by increasing biomass of trees or crops produced per unit of waterused. Plot-level evidence shows that improvements in water productivity as a consequence of modifi-cations to the microclimate of the crop are likely to be limited. Instead, evidence from semi-arid India and Kenya showed that the greater productivity of agroforestry systems is primarily due to the higher amount of water used. Almost half of the total water use occurred during the dry season,when cropping was impossible, and the rest was extracted from soil reserves. This implies a high temporal complementarity between the crop and tree components of the landscape mosaic. Research is needed to examine the impact of the increased water use on the drainage and base flow at the land- scape level. This chapter also describes some of the technical approaches that can be used to improve land and water management, the role of trees and its relation to hydrology and the challenges for rational land-use decision-making.