To develop a sustainable management system of any water resource, it is essential that a balance between the demand of the natural biophysical system and the need of the socio-economic development is achieved. The main challenge that water managers grapple with is how to reconcile the long-term environmental objectives with the short-term political, social and economic needs. Since the biophysical resources underwrite all socio-economic activities, it is imperative that the long-term health of surface water and groundwater systems be the primary driver for sustainable management of water resources. If the environmental need to sustain the ecological values of water is overlooked, then serious water quality problems will arise and the natural aquatic ecosystem will deteriorate to a level such that both social and economic developments become unsustainable. Case studies on water quality and recent water reform initiatives in Australia are discussed in this paper to demonstrate the paramount importance of the biophysical system for sustainable water resources management.