Brent Ozar has some good information on using VMWare and SQL Server: http://www.brentozar.com/archive/2011/05/keys-deploying-sql-server-on-vmware/[/url]. Note this point on his Top Ten List:
8. Avoid 1Gb iSCSI for storage. While this cheap and easy-to-use storage works great for most servers, it doesn’t work as well for SQL Server. If you’re happy with the speed of SQL Server running on local storage, you can be in for a rude surprise with 1Gb iSCSI.
We run our production DB on VMWare and have been very happy with its performance, despite using 1Gb iSCSI. Our DB is small, though, and we have lots of extra RAM on our VMWare farm. I don't administer the VMWare servers nor the SAN, so I don't have a lot to offer: we hired a consultant to help us get the VMWare servers set up, and we're very glad we did.
But it seems to me that trying to run VMWare with only 4 Gb of RAM is asking for trouble. You'd have to do some testing to see if your SQL server is swapping to disk a lot (Buffer Cache Hit Ratio), in turn contributing to the I/O latency you describe. That RAM has to be shared by every virtual machine on your VMWare server(s).
Post back if you find a solution,
Rich