Why does the water content of blood need to remain within narrow limits?
While not a doctor, I can give you a general answer for this.
About 1/2 of blood is water, and the other half is "good goo." The water is important to carry the "good goo" around and help carry bad stuff away from cells. Your body is designed to work with blood that has a very particular make-up in the same way that a car will only go when filled with gas that's made the right way; you can't just mess with it and expect for the car to still go.
Anyhow, your body wants that particular blood design, and since water is such a big part of it you need the right amount. If you have too much water then you have a situation some people call "water intoxication." Basically, when you sweat you lose salt (which is part of the "good goo.") That's okay, because we generally don't sweat a ton and we eat plenty, so we put salt back in. But if the salt level goes down too much and you keep putting water into your body, the blood won't work right. You need the salt level to be constant in order for your nerves and muscles to function correctly. That's not really a problem of having "too much water" in your blood (that's not really possible, you'd just pee out the extra water) but more a case of having blood that is too diluted.
The opposite is a nasty situation called "Hypovolemia." This happens during dehydration. In this situation, you don't have enough water to keep the "good goo" floating well. Your blood doesn't transport oxygen well enough and your body re-directs the limited blood supply to vital organs rather than the skin. This makes it harder to lose heat, which can cause all sorts of troubles if you are exercising.
You can even end up with blood that is TOO salty, your blood pressure will soar, and you'll end up having a heart-attack as your blood pressure rises too high.
So, as you can see just like you can't mess with gasoline you can't mess with blood. It is designed to have a very certain balance, and if you change its composition it won't be able to do the job it is supposed to do.