Prime Minister Fuad Siniora, who was premier when Israel unleashed its military might on Lebanon in July 2006, is battling to form a unity government despite an accord hammered out with the Hezbollah-led opposition in May.
Regionally, there are peace moves afoot between Israel and Syria -- which backs the Lebanese opposition -- although Beirut has still ruled out any negotiations with the Jewish state.
At home, the Lebanese government faces persistent unrest, the latest violence in the northern port city of Tripoli where four people were killed in sectarian gunbattles this week.
In Israel, the government is also in turmoil with the governing Kadima party expected to set a September date for a leadership election to quell a crisis over a corruption scandal embroiling Prime Minister Ehud Olmert.
The fundamentalist Shiite Muslim Hezbollah underscored its political and military strength when it briefly seized control of swathes of mainly Muslim west Beirut in May during days of deadly violence that threatened to plunge Lebanon back into all-out civil war.
"We have still not found a solution to the problem of how can a Lebanese sovereign state coexist with a sovereign Hezbollah state," said political analyst Michael Young.
"The basic problem that was illustrated in the July war has not been resolved, and that is the issue of Hezbollah's weapons."
Israel launched a massive ground and air offensive on Lebanon on July 12 two years ago after Hezbollah guerrillas waged a deadly cross-border raid and captured two Israeli soldiers.
In the ensuing conflict more than 1,200 people were killed in Lebanon, mostly civilians, and 160 Israelis were killed, mostly soldiers, before a UN-brokered ceasefire took effect on August 14.
Hezbollah (the Party of God in Arabic) claimed victory in the 34-day war, but in Israel it was widely considered a failure and resulted in several high-profile resignations, although Olmert has so far resisted calls to quit.
Despite Israel's superior firepower, Hezbollah now has an arsenal of 40,000 rockets, three times more than in July 2006, according to Israeli intelligence officials quoted by local radio.
"It's a mixed bag," said Young. "I don't think the 2006 war was a victory for Hezbollah, but they managed to persuade everyone that it was a victory. In a sense that was quite a success on their part."
In another move seen as a coup for Hezbollah, Israel has approved a deal to release five Lebanese prisoners and the remains of Hezbollah fighters in exchange for the bodies of the two soldiers snatched in 2006.
"It is ironic that Hezbollah was able to achieve through violence what the Palestinian president Mahmoud Abbas was not able to achieve through 10 years of negotiation," said London-based Chatham House's Lebanon expert Nadim Shehadi. "This sends the wrong message really."
Since the war, Lebanon has grappled with a protracted political crisis that pitted the ruling Sunni-led bloc, backed by the West and most Arab states, against the Iranian- and Syrian-backed opposition led by Hezbollah.
The standoff boiled over in May into sectarian gunbattles that left 65 people dead and raised the spectre of a return to the dark days of the 1975-1990 civil war.
As a result, Hezbollah's weapons became a major issue in Lebanon, where the movement insists it can retain its arms as a legitimate "resistance" to Israel.
The crisis ended under a deal brokered in Doha on May 21 which saw army chief Michel Sleiman elected Lebanon's head of state after a six-month void.
The agreement also called for the formation of a unity government giving the opposition veto power, but the cabinet has yet to be formed because of bickering over ministerial posts.
"The incidents in May and the Doha agreement... represent a partial closure of a chapter that opened in 2006," said Paul Salem, who heads the Beirut-based Carnegie Middle East Centre.
"Hezbollah used force and won. (The ruling bloc) had to retreat and we are back to an internal accommodation of Hezbollah."
In the past two years, Lebanon has also faced an Islamist uprising in a Palestinian refugee camp, a series of political assassinations of mainly anti-Syrian public figures and an opposition sit-in that paralysed the heart of the capital.
"Basically we have lost two years of growth. We have been frozen in time," Economic Minister Sami Haddad told AFP.
"We saw zero growth in 2006 and over three percent growth in 2007, whereas we saw six percent growth between July 2005 and July 2006 and this would have been easily achievable the following year."
Finance Minister Jihad Azour said "the economic impact was very painful but the economy has demonstrated strong resilience and ability to spring back."
Azour said the economy saw some recovery after the Doha agreement in terms of foreign investment, capital inflows and a decrease in interest rates.
Despite some political progress, the future remains uncertain.
"A key question for Hezbollah is if Israel and Syria come to a peace agreement, Syria might pressure Lebanon into peace with Israel, leaving Hezbollah with difficult choices to make," Salem said.
"If they don't make peace Lebanon will remain with a two-state solution with the Hezbollah state and the Lebanese state co-existing as they are today."
