UPDATE 1-Malaysia's PAAB plans 20 bln ringgit sukuk-paper

(Adds background, analyst comment)

KUALA LUMPUR, Oct 8 (Reuters) - Malaysian water firm Pengurusan Aset Air will sell 20 billion ringgit ($5.85 billion) of sharia bonds, in what would be the country's biggest corporate Islamic fund-raising, suggesting the frozen sukuk market is thawing.

The company, which was set up in 2006 to take over and restructure Malaysia's water assets owned by individual states, will use around 10 percent of the proceeds to refinance existing debt, Chief Executive Officer Ahmad Faizal Abdul Rahman was quoted as saying by New Straits Times paper.

"The rest is for working capital and a small portion for projects we have started such as the one in Langat, some projects in Johor and others," he told a business conference, according to the newspaper.

"PAAB is targeting to conclude some of water acquisition deals with state governments by this year," he said.

The acquisition of state water assets has hit a snag in opposition-run Selangor state with the state government bidding for assets, saying it would run the water utilities better than private companies.

Privately owned Puncak Niaga (PNHB.KL) has turned down the offer from the state government, saying it undervalued its assets.

Like conventional debt markets, the Islamic bond pipeline has slowed to a trickle due to the credit crisis. Sukuk issuance fell 56 percent to $14.9 billion in 2008, Standard & Poor's said.

Lum Choong Kuan, head of fixed income research at Malaysia's No.2 bank CIMB (CIMB.KL), said issuers are returning to the market.

"Across the whole spectrum, both conventional and Islamic, as an issuer you would think this would be the most ideal time to be raising funds given that interest rates are still considered very low and would have potential to go up in the coming months," he said.

Strong demand for recent Islamic bonds issued by the Indonesian and Bahrain governments and Malaysian state oil firm Petronas [PETR.UL] is encouraging some issuers to come to the market, bankers have said.

($1=3.420 Malaysian Ringgit)

(Reporting by David Chance and Liau Y-Sing; Editing by Soo Ai Peng)