This study is designed to demonstrate use of free remote sensing data to analyze response of water resources and grassland vegetation to a climate change induced prolonged drought in a sparsely gauged semi-arid region. Water resource changes over Hulun Lake region derived from monthly Gravity Recovery and Climate Experiment (GRACE) and Tropical Rainfall Measuring Mission (TRMM) products were analyzed. The Empirical Orthogonal Functions (EOF) analysis results from both GRACE and TRMM showed decreasing trends in water storage changes and precipitation over 2002 to 2007 and increasing trends after 2007 to 2012. Water storage and precipitation changes on the spatial and temporal scale showed a very consistent pattern. Further analysis proved that water storage changes were mainly caused by precipitation and temperature changes in this region. It is found that a large proportion of grassland vegetation recovered to its normal state after above average rainfall in the following years (2008–2012) and only a small proportion of grassland vegetation (16.5% of the study area) is degraded and failed to recover. These degraded grassland vegetation areas are categorized as ecologically vulnerable to climate change and protective strategies should be designed to prevent its further degradation.