I have been giving a lot of thought to the memory issue. This is something that I battled a lot with The OLPC XO
I did some experiments with debian on a QEMU arm box with 128Meg. and had a good look around. The options that struck me as best with regards to window managers Were jwm, OpenBox and Enlightenment. Add to that any number of tiling window managers which, While Lightweight are somewhat of an acquired taste.
OpenBox is the WM behind LXDE and is the primary resident cost of LXDE. It seems to use around 6-7 meg. jwm uses less memory, but seems to not be quite so good at handling window manager hints, sometimes things like Fullscreen windows are a bit wonky.
Enlightenment is a different kettle of fish entirely. It's a Eye candy option but surprisingly lightweight, the underlying libraries have had specific attention paid to ARM+EGL implementation. It is worth looking at http://www.bodhilinux.com/
which is a Ubuntu based distribution using Enlightenment available for 128Meg machines. Right now, the released version is i386 but they have ARM builds in development and operating.
Here's a review of Bodhi. Definitely a thing to keep an eye on.