There is a question on EL&U that discusses the precise meaning "pretty good" and Hippietrail's answer explains it as "Good, to an imprecise degree." So "pretty not terrible" is "not terrible" to an imprecise degree.
In this conversation, the speaker doesn't want to say John Doe is a good person, but they also don't want to say he is a terrible person, so they say he is "pretty not-terrible" (probably only when compared to the rest of the villagers who are terrible in the speaker's opinion).
The speaker is saying that John is about the same degree of "not-terrible" as the degree that someone described as "pretty good" would be "good" or "pretty terrible" would be "terrible".
Suppose I am learning how to cook, and I ask my friend to taste the very first dish I made. Because I'm still learning, I didn't do it well, so it's not good but it is edible. My friend might say "Hey, this is pretty not-terrible! I'm sure you'll do better next time." If I had done it well, but not perfectly, my friend might say "Hey, this is pretty good for a first try! I'm sure the next one will be even better." If I did a bad job on my first dish, my friend might say "This is pretty terrible - maybe you should learn woodworking instead."
Another example is
A lot of the demon lords from Lightspeed Rescue were pretty not-lame. (*)
Those demon lords weren't cool, but they weren't exactly lame either. (I just searched for a real life example, so don't ask me about which demon lords are lame or not - I don't know!)