It can hold up guards
Look, Johhny Soldier can't tell if you're using a water pistol or not when you jump out and tell them to stick 'em up. It means the squirt gun is a viable way to shake them down for info, or make them get on the floor.
It works as a distraction
Like tranqs and other silenced weapons, the water pistol will alert guards if you shoot near them. It doesn't register as an attack either, so you can fire away and drive them nuts.
It soaks, it stuns
The range can make this tricky but a direct shot to the face will stop an alerted guard. Giving you precious seconds to get in and hammer them with CQC
It can put out fires
What, are you surprised?
You can take out electronics
Destroying enemy radar and radio equipment can make your life a lot easier by making it harder for the enemy to organise. But it does tend to make a lot of noise. Not a problem with the water pistol, which can short out delicate electronics with no more than a few quiet sparks.
It can blow up mines
Just in case you don't want to get too close.