I can see 2 reasons Warne got picked over Murali ( apart from bias ).
1. In their head to head encounter, Warne 'won', on Murali's home turf. ( yes, Aus batsmen are probably better, but home ground advantage makes it balanced enough for a comparison ).
2. Murali spent the entire period bowling a delivery which was later proved to be illegal. Apart from the wickets taken with it, others would have been taken while batsmen were looking out for it, etc. We'll never know what effect that had.
I'm not saying the selectors chose correctly ( or not ), just that they did have legitimate reasons to consider Warne better.
In the end, like all these choices the selectors made, it's a judgement call.
Personally, with these and Warne only playing half a season, I'd have been looking closely for a third option...of course, that would have upset everyone