The development of extraocular orbital structures, in particular the choroid and sclera, is regulated by a complex series of interactions between neuroectoderm, neural crest and mesoderm derivatives, although in many instances the signals that mediate these interactions are not known. In this study we have investigated the function of Indian hedgehog (Ihh) in the developing mammalian eye. We show that Ihh is expressed in a population of non-pigmented cells located in the developing choroid adjacent to the RPE. The analysis of Hh mutant mice demonstrates that the RPE and developing scleral mesenchyme are direct targets of Ihh signaling and that Ihh is required for the normal pigmentation pattern of the RPE and the condensation of mesenchymal cells to form the sclera. Our findings also indicate that Ihh signals indirectly to promote proliferation and photoreceptor specification in the neural retina. This study identifies Ihh as a novel choroid-derived signal that regulates RPE, sclera and neural retina development.