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Smallholder farmers in Laikipia district of Kenya, like their counterparts in water scarce semi-arid environments, are facing the challenge of improving agricultural productivity and livelihoods. A number of viable options are available, but high hydrological risks and low economic capability are discouraging the poor and risk-averse farmers. Rainwater harvesting and management (RHM) is one of the promising options, whose impacts are unfortunately also affected by hydrological risks related to unreliable rainfall. The paper presents a hydro-economic analysis of RHM systems with the aim of analyzing some of the factors that affect their adoption by smallholder farmers. Hydro-economic analysis included hydrological reliability of RHM systems, agro-hydrological risks and economic analysis. Agro-hydrological risk focused on dry spell and drought analysis, which affect soil moisture availability and hence crop production. Hydrological reliability assessed the ability of a RHM system to harvest and store adequate runoff to meet supplemental irrigation requirement to bridge dry spells and mitigate the impacts of persistent droughts. Economic analysis addressed benefit-cost analysis and profitability of RHM in terms of increasing crop production and stabilizing yields. The study was conducted in Kalalu and Matanya, which are in two different agro-climatic zones and represent land-use changes in the recently settled areas of Laikipia district. The results provide a basis for farmers to make informed decisions on agricultural investments under hydrologic risks and uncertain production systems. RHM systems for supplemental irrigation were found to be an economically viable option for improving agricultural production and livelihoods of smallholder farmers in drought prone rural areas. (c) 2005 Elsevier Ltd. All rights reserved.