Have you checked if the php GD extension is installed? This is a requirement for Elgg to allow for resizing of images.

Have you checked what happens if you upload an image to the files section? If the resizing fails in the files section, too, you have surely a problem with the GD library and not only an avatar issue.

I'm also having this problem..

I get 'Resize of the Avatar failed" - files upload fine, my GD seems to be all working...

@Bardhili: it could be an issue caused by a 3rd party plugin. I believe it has been mentioned somewhere that the Profile Manager plugin could cause problems with avatar handling. Though I don't know if this issue might have already been fixed it the most recent release of the Profile Manager plugin. I would advise to disable any 3rd party plugins and themes to check out if this solves the issue with avatar resizing. If yes, you only need to narrow down which plugin is responsible. If not, you know at least that the problem is not caused by a 3rd party plugin.