The universe of IS is different from the universe in EP.
"Sumaru City is the main setting for Persona 2: Innocent Sin. It's a fictional Japanese seaside city composed of 5 wards. The name was taken from an in-game historical figure known as Kiyotada Sumaru, a feudal warlord who once ruled the city during the Period Of The Warring States.
It differs from its Eternal Punishment counterpart in many ways, one being that there is no Narumi Ward
."
Quoting from the MegaTen Wiki, Sumaru city is different, there's no Narumi Ward in IS, while in EP there is one. Plus, various shops are changed from the place they were in in Innocent Sin, Philemon didn't just "erased" that part, he created a whole new universe with vasts differents in physical and mental (for some characters) for example, Katsuya Suou (Tatsuya's brother) is shown to be rude and brash in IS but in EP he is actually caring and kind to others,another small example can be that Yukino isn't Maya's partner anymore, and she is a Persona 1 character, she has nothing to do with the IS cast first meeting, and a few other things, such as other characters that had NOTHING to do with the IS cast meeting being alive in the EP Universe while in the IS they're dead.
Referring to the "
The city is showing the signs of recover" line, it's simple, during EP part of the city was lifted by the Ameno Torifune(but got back down when Nyarly was banished, since he can't be killed), causing destruction and the dissapeareance of various places, that's why the city is recovering, because it basically flooded and various wards were destroyed.
About the MFTL feat... The Persona 2 cast were able to hit both Philemon and Nyarlatothep (both are omnipresent beings, hell, Tatsuya punched Philemon right in the face, leaving him a visible bruise, and it was /just/ a jab.)
Also, proof of Nyarly destroying everything in the other side (IS)
http://imgur.com/1k6NaKG
Tatsuya from the Other Side separatting from This Side Tatsuya, and going back to the Sea of Souls (which connects boths universes), proving that it didn't just "erased an event" but different entities, Plus, the memories of Lisa and Eikichi CAN be restored via the Sea Of Souls due to Nyarlatothep tricking them to remember.
http://imgur.com/OF8sire