Most polymeric nanofibers used for bone tissue engineering lack adequate functional groups for bioactivity. This study explores the potential of nanofibers of phosphate functionalized derivative of chitosan-N-methylene phosphonic chitosan (NMPC) for bone tissue engineering. Nanofibers were fabricated by electrospinning of NMPC/PVA blend solutions. NMPC/PVA nanofibers exhibited 172% higher viability of MG-63 cells compared to pure PVA nanofibers. ALP and Collagen type I genes revealed higher expression in NMPC nanofibers on day 3 whereas osteocalcin gene was expressed on day 7. In rabbit tibial defects, NMPC based electrospun graft showed presence of no adverse tissue reaction by histological examination while radiological examination suggested acceleration of bone healing by 300% compared to defects without any scaffold. Thus it is concluded NMPC based nanofibers may have potential for bone grafting applications.