(Semenya wins gold in Berlin)
The 19-year-old world 800m champion has been out of the sport for 11 months after undergoing gender tests.
"The IAAF accepts the conclusion of a panel of medical experts that she can compete with immediate effect," said a statement from the athletics body.
"Please note that the medical details of the case remain confidential."
Semenya could now choose to compete in the World Junior Championships in Canada later in July, with October's Commonwealth Games likely to be her main focus this season.
The teenager said: "I am thrilled to enter the global athletics arena once again and look forward to competing with all the disputes behind me."
Semenya's lawyer Greg Nott said negotiations with the IAAF regarding her return to action had been a lengthy process.
"Our direct negotiations with the IAAF representatives, through the mediator, have been ongoing for 10 months," he said.
"Meetings have been held in Monaco, Istanbul and Paris, but due to the nature of the matter the parties resolved to keep the negotiations confidential."
African National Congress Youth League spokesperson Floyd Shivambu was glad that the verdict had brought an end to the "wild speculations".
"The African National Congress Youth League welcomes the decision of the IAAF to clear South African golden girl Caster Semenya to continue to be an athlete as a woman," said Shivambu.
"It brings to an end the wild speculations that were pushed and celebrated by those opposed to the progress and success of South Africa's historically disadvantaged individuals."
The saga began before her victory in the women's 800m at the World Athletics Championships in Berlin last August.
After lowering her personal best in the event by more than four seconds at the African junior event in Mauritius, Semenya was asked by the IAAF to take a gender test prior to the world championships amid fears she might not be able to run as a woman.
Following the findings of initial tests, the IAAF asked South Africa to withdraw her from their team for Germany but Athletics South Africa (ASA) insisted she should run.
("You have to take certain givens in life - if the IAAF says the girl is clear to run, she is clear to run and we have to find a way to beat her"
UK Athletics head coach Charles van Commenee )
Semenya, then 18, secured victory in the 800m final in an impressive time of one minute 55.45 seconds, 2.45 seconds ahead of defending champion Janeth Jepkosgei.
The IAAF then ordered more tests, saying questions had been raised about her muscular physique, running style and recent stunning improvement in times.
In January, world athletics' ruling body said Semenya was free to run competitively despite its ongoing investigation into her gender, but that was quickly contradicted by South African Olympic Committee president Gideon Sam who said she would not be eligible until the IAAF had made its ruling.
"Hopefully, this resolution will set a precedent so that no female athlete in the future will have to experience the long delays and public scrutiny which Caster has been forced to endure," added Nott's fellow lawyer Jeffrey Kessler.
Meanwhile, UK Athletics head coach Charles van Commenee said his association would accept the decision and his athletes would seek to "find a way to beat" Semenya on the track.
"I respect simply the verdict and the solution and the way forward that the IAAF gives us," he said.
"I'm that sort of person anyway in life. I just stop at traffic lights when they're red. And when they say Dwain Chambers can't compete then he can't compete. When they say we run over 10 hurdles I'm not going to argue we should run over nine or 11.
"You have to take certain givens in life. If the IAAF says the girl is clear to run, she is clear to run and we have to find a way to beat her."
BBC
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