davidfor, thank you so much for tips and sharing your wisdom!
I managed to resize images through the CSS alone but was not really satisfied with how the Kobo's reader was enlarging them. I couldn't really fault it because it was doing the most sensible thing and just using bicubic for enlarging. Since the original images were extremely small and "soft", they were all fairly blurry and way too grey when viewed on Aura.
I ended up opening the ebook with Calibre and then using open-source Imagemagic to enlarge images in a way that sharpened all the edges to minimize the blur and make the images look good on Aura. I spent fiddling with parameters for 30 min, rendered images and then tested them on Kobo.
In the end, I ended up with something that was perfectly readable and looked great to me. I ended up enlarging all images by 300% and applying various sharpen filters (which ones you apply depends heavily on source material so the keys is to try and see what works).
Here's some examples...
Original:
Bicubic:
Custom:
others:
I think this is the way to go when faced with the issue of ebooks with small images. Kobo/Eink readers prefer images with better contrast.
Thanks again and hopefully this helps others as well.