Madagascar was plunged into diplomatic isolation and donors froze direct aid worth 40 percent of the Indian Ocean Island’s budget when Andry Rajoelina grabbed power with military backing in 2009.
On Saturday, Rajoelina handed the presidency to Hery Rajaonarimampianina, a former finance minister, after presidential and parliamentary elections took place in calm conditions last month.
"(The Council) decides, in view of the completion of the transition process and restoration of constitutional order ... to lift the suspension of Madagascar's participation in the activities of the AU," the organisation's Peace and Security Council (PSC) said in a statement.
The African Union is a pan-continental bloc made up of 54 African states whose stated objectives include promoting peace and security on the continent, protecting human rights and encouraging sustainable economic development.
The PSC said it had also decided to lift "all other measures" against Madagascar and urged the international community to provide support to the nickel-producing economy.
However, international lenders may not be ready to act just yet. The World Bank told Reuters on Friday it wanted to see the formation of a new government before it would resume normal relations and give budget support.
The Malagasy authorities have not yet released official results of the legislative election, which was held on the same day as the runoff of the presidential vote on December 20.