Other way around -- grog wasn't so much diluted with water as the grog was applied TO the fresh water as an antiseptic.
Fresh water on ships had typically been sealed inside a barrel for months or even years before it was consumed, growing all manner of unhealthy pathogens. Pre-germ theory people read this as "it smells and tastes bad," which is a pretty good first-order approximation of germ theory.
When you cut that contaminated water with alcohol, that greatly reduces illnesses from drinking it, especially in those whose GI systems are already somewhat adapted to tolerate the pathogens. Strong spices in grog such as cloves also helped mask the taste of drinking years-old barrel water.
Fresh water on ships had typically been sealed inside a barrel for months or even years before it was consumed, growing all manner of unhealthy pathogens. Pre-germ theory people read this as "it smells and tastes bad," which is a pretty good first-order approximation of germ theory.
When you cut that contaminated water with alcohol, that greatly reduces illnesses from drinking it, especially in those whose GI systems are already somewhat adapted to tolerate the pathogens. Strong spices in grog such as cloves also helped mask the taste of drinking years-old barrel water.