It's hard to tell from the picture but it looks like a spring tensioner to take up slack in the sanding belt. Can you rotate the small pulley either clockwise or counter-clockwise around the large pulley? Does the small pulley resist being rotated? Is the belt tight as it is now installed?
From what I can see, my best guess would be that you rotate the small pulley counter-clockwise (with the belt slack) and pass the belt "under" the small pulley. This would maintain tension as the belt stretches.
The problem (?) with this is that the sanding (rough) side of the belt would be running on the face of the small pulley.
Having said all this, I could be all wet but hope it gives you some ideas. Someone else might have more experience with this type of machine and be able to give a definite answer.
Best of luck,
Jim