Hydronephrosis is caused by excess fluid in the kidney as a result of urinary outflow obstruction. The renal pelvis and the calyces become dilated causing atrophy of the surrounding parenchyma.
In this photograph are two kidneys. Note that the kidney on the right has a massively dilated renal pelvis. There are many causes of obstruction to urinary outflow e.g. prostatic hypertrophy, pregnancy, and stones.