The limitation includes UI elements, but not text (that would just be unfair).
Does that mean you can't use procedural graphics, like a 2D rectangle drawing function, all of the graphics must be from your 128x128 texture?
Procedural graphics are allowed. So any drawing functions you have are totally viable.
is it also allowed to manipulate the loaded images (palette swapping, changing pixels, merging parts of tiles, rotating mirroring)
Yes all of that is allowed.
