Shrub encroachment in arid and semi‐arid grasslands is increasing due to global environmental changes, leading to greater vegetation and soil heterogeneity that threatens carbon sequestration. Alterations in global precipitation patterns and nitrogen (N) deposition impact water and nutrient availability, affecting carbon dynamics in these ecosystems. Despite this, existing research mainly focuses on traditional steppe ecosystems, with limited understanding of variations across different stages of shrub encroachment and within heterogeneous patches.This study utilized a 4‐year (2020–2023) experimental approach in Inner Mongolia's shrub‐encroached grasslands, involving water and nitrogen (N) additions, to investigate carbon exchange parameters (NEE, GEP and ER) within both shrub and herbaceous patches. It assessed the effects of increased precipitation and N enrichment on carbon exchange and stability (resistance, resilience and temporal stability) across different stages of encroachment (non‐encroached, light, moderate and severe).Water addition significantly enhanced net ecosystem carbon exchange (NEE) in shrub‐encroached grasslands, particularly during dry years (2020 and 2022). Although N addition had a minor impact on NEE, its effect varied with the extent of shrub encroachment. Herbaceous patches were more responsive to water addition, while shrub patches showed stronger responses to N addition.The interaction between water and N was modulated by interannual precipitation variability and the level of shrub encroachment. Co‐additions of water and N promoted carbon sequestration during dry years with synergistic effects but exhibited antagonistic effects during wet and normal years. As shrub encroachment increased  the impact of water–N interaction on NEE transitioned from antagonistic to synergistic or additive. Notably, water addition enhanced drought resistance in shrub patches. Despite greater stability in shrub patches compared to herbaceous patches, the post-drought resilience of ecosystem decreased with increasing encroachment intensity. These findings provide insights into the long‐term impacts of shrub encroachment on ecosystem stability. Future assessments should consider differential responses across encroachment stages and heterogeneous patches to better understand how changes in precipitation and N deposition affect the structure, function and stability of shrub‐encroached grasslands. This study offers a novel perspective on the carbon cycling mechanisms in these ecosystems, informing evaluations of their carbon sequestration potential.