Most post-hostility treaties benefit one country at the expense of another. China has grabbed huge chunks of land from its neighbors after beating them in battle.
The water theory doesn't hold water. Countries without fresh water have been figuring out how to supply themselves since forever. The principal problem relates to agriculture, which requires huge amounts of essentially free water. Singapore used to rely on Malaysia for cheap water. It has now weaned itself off. The Gulf emirates have never had cheap water, but they have somehow made do.
Well, it was a nice story.
More likely, the Brits recognized that the balance of power in the region had shifted in China’s favor and accepted the “one country, two systems” solution as a face-saving compromise. I’ve long felt that was the case.