$Mycobacterium\; leprae$ causes leprosy and is unique among mycobacterial diseases in producing peripheral neuropathy. This debilitating morbidity is attributed to axon demyelination resulting from direct interaction of the $M.\; leprae$-specific phenolic glycolipid 1 (PGL-1) with myelinating glia and their subsequent infection. Here, we use transparent zebrafish larvae to visualize the earliest events of $M.\; leprae$-induced nerve damage. We find that demyelination and axonal damage are not directly initiated by $M.\; leprae$ but by infected macrophages that patrol axons; demyelination occurs in areas of intimate contact. PGL-1 confers this neurotoxic response on macrophages: macrophages infected with $M.\; marinum$-expressing PGL-1 also damage axons. PGL-1 induces nitric oxide synthase in infected macrophages, and the resultant increase in reactive nitrogen species damages axons by injuring their mitochondria and inducing demyelination. Our findings implicate the response of innate macrophages to $M.\; leprae$ PGL-1 in initiating nerve damage in leprosy.