Bafana's hopes of reaching next year's continental showpiece in Cameroon suffered a setback as they were held to a 0-0 draw by the Mediterranean Knights at Moses Mabhida Stadium.
Libya showed little respect for the hosts and had great chances to tighten their grip on Group E in Durban.
Rabia Ramadan Al-Ashadi had a shot in the box well saved by Itumeleng Khune at the near post, while Anias Mohamed Jummah Saltou sent an effort against the woodwork with Khune well-beaten after Bafana debutant Vincent Pule was nearly punished for being caught in possession.
Baxter pointed out many former minnows such as Iceland have raised their game in world football. There was a fresh reminder of this on the weekend as 10-man Kenya stunned Ghana 1-0 in Nairobi.
"I said before the game, Libya play two different ways. I have seen them play two different ways and play two different ways in one game," Baxter said.
"So I knew they can be more aggressive, play a pressing game and I knew that they could drop off and try and tempt us to press higher and get in behind us.
"So we had to practise two different games as well and the players did a good job in terms of that, because they didn't get the goal. We were the ones who were supposed to push on and win the game.
"We could've very easily been caught out with our trousers down. Maybe you guys were surprised in that they are a very tiny football team, but they work a lot together, more than most national teams.
"Therefore I said they don't have the Sadio Manes there with that extreme talent, but they do have a team that functions as a team.
"I also said to you guys before, Iceland were the whipping boys five years ago but now not anymore. Football has evolved and it is difficult to break teams down."
After dropping points against Libya against expectations, Bafana will be under more pressure next month when they take on Seychelles in back-to-back matches. The islanders lost 5-1 to Libya and 3-0 to Nigeria last night. Bafana share the Group E summit with Libya on four points apiece after two fixtures.
Asked why South Africa struggle to put sides away that are seemingly weaker on paper, Baxter acknowledged a mental frailty in his charges.
"My experiences of the two games against Cape Verde [in the FIFA World Cup qualifiers last year] where I expected us to win; if you look at that I think they are both examples of when it doesn't go according to plan, what do we do?
"If you don't have a base in place and anxiety and panic sets in, you then play below the level you should play. I think that's what happens and that is what happens a lot.
"When it doesn't go according to plan, players know the repercussions. They know that you guys are going to hammer them. They know that they're going to be embarrassed. They know they're going to lose points and not make the nation proud ... they're aware of all that and they are very patriotic.
"So they worry about it. Now you can say they should be mentally strong. There are certain things that are going to happen then and you can't play and not be mentally strong, because if you depend on that pat on the back, shibobos, then you've not got real confidence.
"Really confidence comes from repeating something a lot and making sure that I can do that no matter who the opponent is."