The objective of this study was to evaluate the osteoinductivity of composite chitosan-nano-hydroxyapatite scaffolds in a rat muscle pouch model. Previous in vitro characterization demonstrated the ability of the scaffolds to promote bone regeneration and as a carrier for local delivery of BMP-2. Composite microspheres were prepared using a co-precipitation method, and scaffolds were fabricated using an acid wash to adhere beads together. To determine the in vivo osteoinductivity of the scaffolds, the following groups (n = 6) were implanted into muscle pouches created in the latissimus dorsi of Sprague Dawley rats: (A) lyophilized scaffolds without rhBMP-2, (B) lyophilized scaffolds with rhBMP-2, (C) non-lyophilized scaffolds with rhBMP-2, and (D) absorbable collagen sponge with rhBMP-2 (control). Groups B, C, and D were loaded with 4 mL of a 9.0 μg/mL solution of rhBMP-2 for 48 h. The rats were sacrificed after one month and samples were analyzed for amount of residual implant material, new bone, and osteoid. Although the experimental groups displayed minimal degradation after one month, all of the scaffolds contained small amounts of woven bone and considerable amounts of osteoid. Approximately thirty percent of the open space available for tissue ingrowth in the scaffolds contained new bone or osteoid in the process of mineralization. The ability of the composite scaffolds (with and without BMP-2) to promote ectopic bone growth in vivo was demonstrated.