Nowadays it can be obtained by participating in any of the activities at the (yearly) Summer Beach Party event, just West of Lumbridge.
The water balloon has a right click "Pop" option, which prompts the user with a field to input the amount of balloons to be popped (even if you only have 1 in your inventory). After confirming the amount, a skill can be selected. The amount of experience gained per Water balloon is 10% of the chosen skill's level, except for Invention it is 5% of your current Invention level.
You can also wield Water balloons, and when you do all other players will have a 'Pelt' option. If you click on another player, you will throw one of your balloons at them. This does not cause any damage.