Argonaute-1 (Ago-1) plays a crucial role in gene regulation and genome stability via biogenesis of small non-coding RNAs. Two "Argonaute" family genes, piwi and Ago-2 in Drosophila are involved in multiple silencing mechanisms in the nucleus, transgene cosuppression, long-distant chromosome interaction, nuclear organization and heterochromatin formation. To investigate whether Ago-1 also plays a similar role, we have generated a series of Ago-1 mutations by excising P element, inserted in the Ago-1 promoter (Ago-1k08121). AGO-1 protein is distributed uniformly in the nucleus and cytosol in early embryos but accumulated predominantly in the cytoplasm during the gastrulation stage. Repeat induced silencing produced by the mini-white (mw) array and transcriptional cosuppression of non-homologous transgenes Adh-w/w-Adh was disrupted by Ago-1 mutation. These effects of Ago-1 are distict from its role in microRNA processing because Dicer-1, a critical enzyme for miRNA biogenesis, has no role on the above silencing. Reduction of AGO-1 protein dislodged the POLYCOMB, EZ (enhancer of zeste) and H3me3K27 binding at the cosuppressed Adh-w transgene insertion sites suggesting its role in Polycomb dependent cosuppression. An overall reduction of methylated histone H3me2K9 and H3me3K27 from the polytene nuclei precisely from the mw promoters was also found that leads to concomitant changes in the chromatin structure. These results suggest a prominent role of Ago-1 in chromatin organization and transgene silencing and demonstrate a critical link between transcriptional transgene cosuppression, heterochromatin formation and chromatin organization. We propose Drosophila Ago-1 as a multifunctional RNAi component that interconnects at least two unrelated events, chromatin organization in the nucleus and microRNA processing in the cytoplasm, which may be extended to the other systems.