McFadden was beginning to discover his top form when he suffered cruciate ligament damage in training last month.
It was initially feared that the 27-year-old would be sidelined for at least six months and, by the time he had regained match sharpness, the season would effectively be over.
However, McLeish is now optimistic the Scotland international could make a comeback after Christmas.
"He's progressed very well, but we have to put the reins on him," said McLeish.
"It's a cruciate injury. No matter how players recover from it, they certainly don't recover in two or three months.
"We have to put the brakes on his own passion to get fit again.
"He's doing some light weights, some bench presses, some leg presses. Things like that. One of the physios is working with him every day.
"Will he be back before the end of the season? I think he could be. Stefan Klos made a great recovery at Rangers from the same sort of thing when I was there.
"I think he was back in four or five months and James has shown that kind of progress as well."
He added: "It was a shame it happened when it did because I felt James was going to have a big season and he had just played very well against Liverpool.
"It also hampered our striking situation because the others weren't quite ready to return."
McFadden is out of contract at St Andrews at the end of the season, although the Blues have a two-year option in their favour they can apply.
McLeish said: "I wouldn't think that we would be letting a guy like James McFadden walk out of here free."
Aston Villa 4/5, Draw 5/2, Birmingham 7/2
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