To increase vegetation coverage and improve ecosystem services, the government has promulgated and implemented the “Grain for Green” policy since 1999. How and where vegetation cover increases and how land use/land cover (LULC) changes determine regional water resources and hydrological regimes. On the Chinese Loess Plateau (LP), an arid and semiarid area with fragmented topography and the transitional vegetation nature, accurately predicting LULC and vegetation change is particularly important. We employed a simple habitat analogy approach, and the Soil and Water Assessment Tool (SWAT) to predict potential vegetation restoration and LULC change and investigated their impact on the hydrological regime in a watershed of Liujiahe. Results showed that the maximum recoverable vegetation cover of the Liujiahe watershed is 71.1%, of which 9.2% still has potential for vegetation cover and 36.4% of the area vegetation continued to improve in the future. Future suitable afforestation areas are limited to 46.06 km2, which will result in cropland will decrease by 47.4%, and grassland and forestland will increase by 15.8% and 0.7%, respectively. However, SWAT results showed that vegetation restoration between the 1980 s and 2020 s has already reduced the annual mean runoff and soil water content (SW) by 44.2% and 43.9%, respectively, while evapotranspiration (ET) has increased by 12.6%; LULC changes in the next 30 years will further reduce runoff and SW by 15.6% and 11.1% respectively, and increase ET by 1.2%. Overall, large-scale vegetation restoration has greatly affected hydrological regimes on the LP. The area still has potential for vegetation enhancement; however, considering the limited rainfall and water-carrying capacity, the vegetation restoration of this watershed should be based on natural restoration or low water consumption grasses and shrubs to avoid a water resource crisis. These results provide a perspective for modelling LULC changes in areas with fragmented terrain and highly influenced by human activities, and provide an important basis for sustainably managing natural resources on the LP under long-term ecological restoration.