Try our new info resource - "Aladdin's Cave" (Main menu)Just added a separate link to Ash's Dropbox thread (shortcut)
They often used paint of various types inside castings to avoid any porosity in the metal allowing the oil to pass through to the outside. Not quite sure of the reasons it's used in these engines but someone else may be able to add more to it. They were at the time trying to make them as leak free as possible in comparison particularly to British made engines. I guess you'd get too much drop out from production runs to even test them all, so easier to use an oil resilient paint in coating the inside to reach the consistent standard they were aiming for.
Personally I would remove the loose/bubbled paint, any solid debris breaking loose inside the motor can cause havoc. Even if it doesn't block the pick up gauze on the pump, do you really want it gunging up the gear clusters and gearbox bearings?
Tat O ring should be 18 x 3
Your kick start shaft is too close to the clutch basket. Put the clutch cover on, then the kick start lever, turn the engine with the lever while pulling it back and locate the cover up. If that doesn't work, report back.
you also need the shaft holder fitted to the left side, to line up the gear box shaft