Water availability is becoming a critical issue in Ethiopia in arid and semi-arid areas mainly in Rift Valley. Field experiment was carried out at Melkassa Agricultural Research Center, Ethiopia during growing season 2017/8 under furrow irrigation system and eight irrigation treatments replicated three times in a randomized complete block design. Hence, the objective of this study was to establish critical moisture stress threshold level for improving production and water productivity of irrigated onion under limited water resource condition. In the study, irrigation treatments consisted full supply of irrigation 100% ETC (control) and seven stress levels were imposed on onion nafis variety through growth stages. Obtained results revealed that, the highest seasonal water requirement value of 422.1 mm was by the 100% ETC while, the lowest value of 198.8 mm was by 40% ETC. Analysis of the data obtained showed significant (p<0.05) effects of soil moisture stress treatments on onion growth parameters. Analysis of the data obtained showed significant (p<0.05) effects of soil moisture stress treatments on onion bulb yield and yield components. The study revealed, yield response factor (Ky) for the onion was showed there is yield reduction as crop stressed. Highest Marginal rate of return was obtained from 70% ETc of 24914.3% and decrease to 90% ETc of 2155.4%.The study has concluded that moisture stress through growth stage significantly influenced onion bulb yield. Therefore, the critical stress level of the onion from this study could be irrigated at 75% ETC to increase WP without a significant yield reduction and economically visible. The study suggests that moisture stress strategy should be adopted for optimum yield and maximum water productivity without a significant yield reduction.