While ameliorating effects of melatonin (MT) on abiotic stress tolerance in plants are widely reported, the mechanism that underlies this process remains elusive. This work investigated mechanisms by which MT improved drought tolerance in pepper (Capsicum annuum) plants. A foliar spray of 0.1 mM MT treatment was applied to plants grown at 80% and 40% of full field capacity for 3 days. Drought stress caused a significant decrease in plant dry weight, relative water content, leaf water potential, PSII efficiency (Fv/Fm ratio), chlorophyll, soluble protein, leaf and root nitrogen content. Drought increased hydrogen peroxide, malondialdehyde (MDA), nitrate, ammonium, free amino acids, soluble sugars, proline and glycine betaine. Drought also increased peroxidase (POD), glutathione S-transferase (GST) and catalase (CAT) activities, electrolyte leakage (EL) and methylglyoxal (MG). MT pre-treatment reduced oxidative stress and improved nitrogen metabolism by activating various enzymes such as nitrate reductase (NR), nitrite reductase (NiR), glutamine synthetase (GS), glutamate synthetase (GOGAT) and glutamine dehydrogenase (GDH) activities. It also activated enzymes related to the glyoxalase system (Gly I and Gly II) and decreased NO3−, NH4+ and free amino acid content. Our study suggests a cost-effective and sustainable solution to improve crop productivity in water-limited conditions, by enhancing plant growth, photosynthesis and nitrogen content.