Bailey is competing against Shaun Marsh, Usman Khawaja and Phil Hughes for a spot in the first Test vs England, starting in Brisbane on November 21.
Cricket Australia has released the left-handed opening batsman from the Ashes squad to join Australia A to play Zimbabwe XI and South Africa A.
The former refugee played for Australia A last month in England and selector John Inverarity has indicated he will be considered for the Ashes squad.
Ahmed returned home from England in June after the government moved a bill through the upper house of parliament to amend the Citizenship Act to help fast-track his application.
Australia's Ashes campaign lurched into further crisis earlier on Monday when coach Mickey Arthur was sacked with Darren Lehmann expected to be announced as his replacement.
Meanwhile captain Michael Clarke, now Australia's best batsman, hasn't played a competitive match since March due to a recurrence of a back injury he suffered in India and was absent again as the team's Champions Trophy exit was confirmed by Monday's 20-run loss to Sri Lanka at The Oval.
Currently, according to the International Cricket Council's Player Eligibility Criteria, Ahmed will only become eligible for national selection on August 18. But CA said should the bill become law, and Ahmed obtains citizenship and an Australian passport before that date, he will immediately be available for the national side.
Chris Rogers returns, five years after his only Test against India while James Faulkner too makes the cut. Brad Haddin in the wicket-keeper and the vice-captain but Matthew Wade could play as a specialist batsman.
Commenting on the decision, Watson said, "Making the decision to step down wasn't easy but it's something I've been thinking about since the Test series against India ended."
We are very much in a transition stage in Australian cricket and are looking to some young players to come through, says selection committee boss.