Since its 1998 launch the Smart Fortwo has racked up 770,000 sales and become one of the most recognisable cars on the road. Yet a second generation of the quirky two-seater nearly didn’t happen because the Smart project has never turned a profit.

First conceived as a cute, affordable urban runabout with space for two and a case of beer, the original Smart car was priced competitively in the hope that efficient distribution would help offset costs. This never happened and when Smart’s range-expanding Roadster and Forfour were axed because of poor sales, the future of the brand hung in the balance.

Happily, Mercedes decided to persist with the Fortwo, and the result is this redesigned and improved version. The parent company, DaimlerChrysler, claims the reengineered format is cheaper to produce, and this, together with the fact that the Fortwo is to be sold in America for the first time, makes the future look brighter. More important, perhaps, is the fact that this ultra-efficient car may help DaimlerChrysler bring down the average CO2 emissions on its cars to 130g/km by 2012 to meet the European Union’s proposal on emission reductions.

While the new Smart looks familiar, 90% of the car is new. It is longer than its tiny predecessor — the extra being necessary to meet American crash regulations and Europe’s pedestrian impact laws. The build quality of the original, though never bad, has been improved. The dashboard is better laid out and less quirky, and the cabin’s materials and fittings look classier than you’d expect.

Best of all, virtually all the demerits of the original model have been banished. One of the biggest was a semi-automatic gearbox incapable of switching out of lazy-Sunday-afternoon mode, which made early Smarts as frustrating as a pushbike with a jumping chain. The experience wasn’t enhanced by the bobbing ride, slow-witted steering and an alarming uncertainty in bends.

While some of these failings were remedied during the life of the first model, making the post2003 versions almost acceptable, the new car is much more fun to drive. New engines and a new gearbox in particular have worked wonders. The engine is a three-cylinder unit as before, but it’s new, co-designed with Mitsubishi, more powerful and equally economical. It can be had with three power outputs (four if you include the tuned Brabus version that comes later) ranging from 61 to 84bhp. All three slip beneath the proposed CO2 emissions threshold of 120g/km that would qualify for congestion-charge exemption in London. Mainland Europe will also get an 84mpg diesel emitting 90g/km. Ultra-frugal motorists in Britain will have to wait for an all-electric version, build by a separate company, expected within two years. The engines are mated to a five-speed gearbox with a gearchange some 50% faster than before.

The new Fortwo is more athletic, too. Wider tyres, extra length and width, some suspension tweaks and quicker steering all improve agility. The greater length also improves cabin space, although it makes the car a little less easy to park. Most coupé versions have a clear plastic roof (with blind) that makes the colourful interior feel more spacious still, while the cabriolet now provides an effortless motorised retractable roof.

The turbocharged Fortwo Passion Coupé will be the bestseller, and although its projected £9,000 price sounds a lot for a city two-seater, it is unexpectedly brisk, and now really rather good through the bends. It has responsive steering, doesn’t balk at bumps and retains great inner-city nippiness. You can have it with or without power steering — with is better.

The Passion Coupé cruises happily at 70mph, and even the 71bhp nonturbo version feels decent out of town. Insensitive brake pedal and noisy ventilation fan aside, this car is a resounding success. With its rough edges now buffed, and small cars making increasing sense, this radical little newcomer deserves to succeed.

Vital statistics

Model Smart Fortwo Passion Coupé

Engine type 999cc, three-cylinder turbo

Power/Torque 84bhp / 89 lb ft

Transmission Five-speed automatic

Fuel/CO2 57.6mpg (combined cycle) / 116g/km

Performance 0-60mph: 10.9sec / Top speed: 90mph

Price £8,960 (estimate)

Verdict Small car, great big smiles

Rating 4/5

Date of release 4/5

The opposition September

Model Ford Sportka £9,995

For Great to drive, four seats, cute

Against Cheap-looking cabin

Model G-Wiz AC £8,299

For Electric so no (local) pollution, cheap to run

Against No Euro NCAP safety rating, cramped, shoddy