To create a new virtual machine named VM2 which is connected to VNET1 in RG1, you need to remove Microsoft.Network/virtualNetworks from the policy. This is because the Not allowed resource types Azure policy denies the deployment of the specified resource types in the scope of the assignment. In this case, the policy is assigned to RG1 and uses the parameters Microsoft.Network/virtualNetworks and Microsoft.Compute/virtualMachines. This means that you cannot create or update any virtual networks or virtual machines in RG1. Therefore, to create VM2 and connect it to VNET1, you need to remove Microsoft.Network/virtualNetworks from the policy parameters. This will allow you to create or update virtual networks in RG1, but still prevent you from creating or updating virtual machines. Alternatively, you can also exclude VNET1 from the policy assignment scope, but this will affect the compliance of the policy for the entire virtual network.
Reference:
Not allowed resource types (Deny)
Create and manage policies to enforce compliance