Debian – Need to edit boot.lst from busybox

Regarding the bootmanager: when using FAT as filesystem then syslinux would be one approach. Especially when booting from USB you might consider using grub for booting, as you'll be flexible with the grub shell (providing a nice tab-completion). To install grub you'd be running something like:

mount /dev/sdX /mnt/
grub-install --recheck --no-floppy --root-directory=/mnt /dev/sdX

and adjust /boot/grub/menu.lst accordingly.

Your bootloader has to load kernel and initrd. So those files have to be outside your debianroot.img (unless you're using the ISO approach and grub2 with its loopback option, see http://michael-prokop.at/blog/2009/05/25/boot-an-iso-via-grub2/) and need to be referenced/configured in your bootloader (being syslinux.cfg for syslinux, menu.lst for grub1 and grub.cfg for grub2). The following is an example menu.lst file used for the grml live system (http://grml.org/) generated by grml2usb (http://grml.org/grml2usb/):

# misc options:
timeout 30
splashimage=(hd0,0)/boot/grub/splash.xpm.gz
foreground  = 000000
background  = FFCC33

title grml  - Default boot (using 1024x768 framebuffer)
kernel (hd0,0)/boot/release/grml/linux26 apm=power-off vga=791 quiet boot=live nomce live-media-path=/live/grml/ 
initrd (hd0,0)/boot/release/grml/initrd.gz

The initrd file has to locate the debianroot.img on your devices and loopback mount it then. Then it should change your root file system via e.g. pivot_root (see http://linux.die.net/man/8/pivot_root) to inside the mounted loopback file. You can find more details regarding the initrd process in Documentation/initrd.txt of the linux kernel sources: http://lxr.linux.no/linux/Documentation/initrd.txt

If you'd like to know how common live systems do this kind of stuff check out debian-live (http://debian-live.alioth.debian.org/) or grml-live (http://grml.org/grml-live/) in combination with live-initramfs (which does all the initrd/initramfs magic and is used in most Debian based live systems; http://packages.debian.org/sid/live-initramfs).

A different approach to your debianroot.img approach would be talking an existing Debian based Linux Live system providing so called "root persistency" (for example the official Debian-live project provides this as well as grml 2009.05 does).

mount: cannot read /etc/fstab: No such file or directory

That's a pretty clear sign that your initramfs is borked. Probably because your install is borked.

How did you get past partitioning in debian-installer? Last time I did it (ummm... yesterday) I had to export something that I could partition, so your disk being hda1 is rather weird. Mine looks like:

disk = ['phy:/dev/GLaDOS/xen-portaltest,xvda,w']

its on a logical volume, not a file, but that shouldn't matter. Giving it xvda1 or whatever didn't work; it wanted to partition that, which is fairly silly.

With xvda, I went ahead and partitioned that (into a xvda1 for /boot and an xvda2 for a LVM physical volume, but you could certainly just use that for root). The installer then completed normally, and it works after dealing with the bootloader not executable error documented on the Debian Wiki's Xen entry.