In this paper, control and operation of a microgrid having inverter based solar photovoltaic (PV) and diesel engine is presented. The microgrid is designed to meet rural applications. In the proposed microgrid, a water pumping system is considered as a dump load for ensuring economic operation of microgrid. Three scenarios i.e fully loaded, partially loaded and lightly loaded are considered to evaluate the performance of proposed microgrid. In fully loaded condition, PV operates at MPPT for extraction of maximum power and the diesel generator is operating at rated power. In second scenario, when the power demand is less, PV operates in de-rating mode to avoid operation of diesel generator below minimum operating limits; and thus ensures economical operation of the microgrid. However in lightly loaded condition or in case of low solar irradiation when PV power is already close to zero; a dump load is turned ON to ensure the operation of diesel generator in proper technical range. The paper shows the control of water pump as per the available demand and generation. To verify the performance of the proposed system, simulation in MATLAB/SIMULINK environment is performed and it is concluded that proposed microgrid with water pumping system as dump load ensures economical operation of microgrid. © 2017 IEEE.