The mammalian striatum controls the output of the basal ganglia via two distinct efferent pathways, the direct (i.e., striatonigral) and the indirect (i.e., striatopallidal) pathways. The LIM homeodomain transcription factor Islet1 (Isl1) is expressed in a subpopulation of striatal progenitors; however, its specific role in striatal development remains unknown. Our genetic fate-mapping results show that Isl1-expressing progenitors give rise to striatal neurons belonging to the striatonigral pathway. Conditional inactivation of Isl1 in the telencephalon resulted in a smaller striatum with fewer striatonigral neurons and reduced projections to the substantia nigra. Additionally, conditional inactivation in the ventral forebrain (including both the telencephalon and diencephalon) revealed a unique role for Isl1 in diencephalic cells bordering the internal capsule for the normal development of the striatonigral pathway involving PlexinD1-Semaphorin 3e (Sema3e) signaling. Finally, Isl1 conditional mutants displayed a hyperlocomotion phenotype, and their locomotor response to psychostimulants was significantly blunted, indicating that the alterations in basal ganglia circuitry contribute to these mutant behaviors.