The effective management of natural resources is increasingly critical for growth and development in India. The research examines the nature and impact of the interaction between formal and informal institutional structures in the rural areas in the context of the implementation of the major national initiative of watershed development programmes in India. It uses the concepts of new institutional economics and management theories of governance. It develops a conceptual framework which can be used to understand and explain the need and dynamics of institutional interaction and its relationship to institutional performance. The relevance of the framework is examined through case studies and a primary survey on the determinants of institutional performance in Andhra Pradesh, India. It seeks to contribute to the theory of institutions and the better design of institutions in watershed development.