Nihalani was born on 1940 August 19 in Karachi (now in Pakistan) and his family migrated to India during the partition of 1947. He started out as a cinematographer, graduating in cinematography from the Shree Jaya Chamrajendra polytechnic in Bangalore in 1962. He was associated with all the earlier films of Shyam Benegal and with the cinematography of Richard Attenborough's Oscar-winning epic Gandhi. Nihalani and Benegal are well known for their socially relevant films.
His first directorial venture was Aakrosh starring Om Puri, Naseeruddin Shah, the late Smita Patil and the late Amrish Puri. This was based on a real story which was converted into a film script by the eminent Marathi playwright Vijay Tendulkar and it made a huge impact on audiences all over India. It shared the Golden Peacock for best film at the International Film Festival of India held in New Delhi in 1981. His film Ardh Satya, based on a story by Dilip Chitre, is still remembered by film lovers. It changed forever the way in which Indian cinema portrayed the police and it exposed in stark detail the police-politician-criminal nexus. Over the years he has directed many films which are known for the manner in which they grab the viewer's attention, and his most recent work is the 2004 film Dev.