GROZNY – The word was on the streets by the beginning of the month. The market in the center of this Russian-occupied and nearly razed city had never been busier. Truckloads of bread sold out every hour. Cucumbers, garlic and tomatoes, the staples of summer life here, were moving by the crate.

''They told us,'' said Tamara Pipkin, 42, who somehow survived under the nearly endless siege conditions in Grozny in the last two years. ''The fighters said they were coming in on the 6th. They told us to get food and water and go into the basements. They said they were taking the city back.''

And they did. Before dawn on Aug. 6, 1,500 Chechen separatists led by Shamil Basayev, their most aggressive and successful field commander, embarked on the Second Battle of Grozny.

They moved in from three directions: east, west and south. Before the battle was over this week, the Russian Army and Interior Ministry — with nearly 30,000 soldiers stationed in this devastated republic in southern Russia — had been routed, driven completely from the secessionist capital they captured at enormous human cost in January 1995.

The defeat at first seems impossible to comprehend. The Russian Air Force nearly leveled Grozny last year and has since reduced much of the rest of Chechnya to ashes, killing tens of thousands of civilians, humans rights groups estimate. The Russians have at least 10 times the soldiers in Chechnya, and many times the wealth, of their opponents.

But as Aleksandr I. Lebed, the national security adviser now in charge of the Russian war effort, pointed out at two news conferences this week, the leaders of the Russian forces in Chechnya are corrupt, the soldiers are poorly trained, rarely paid and badly equipped, and consequently they have no will to win.

The Chechens, on the other hand, are pursuing a centuries-old vow to drive the occupiers from their land, which is one of the many republics that make up the Russian Federation.

They long ago decided that it would take drastic action to make Russia realize that its war here has largely been futile. And so, silently, they began to plan.

In March, in what Mr. Basayev described as a ''dress rehearsal'' devised by their late leader, Gen. Dzhokhar M. Dudayev, the rebels rolled into Grozny on a train, killed scores of Russian soldiers, burned much of the city and then withdrew to the mountains.

Relying on a vast horde of weapons, most of which were captured, bought or stolen from the enemy, the separatists agreed at a meeting on July 25 that this time they would finish the job.

''We had to come to Grozny because this is where we can kill the most Russians,'' Mr. Basayev said this week in a sometimes chilling interview in his command post in the center of the city. ''We had to make them understand that we will never give our country away.''

The Battle: 'This Is a Game Of Cat and Mouse'

Last month, this was a city of 350,000 people living tenuously under Russian occupation. Every bridge had a checkpoint, every Government building a heavy brigade of guards. No one dared venture out at night when the Russian soldiers got drunk and the Chechen separatists came in to pick them off, a few each day.

Today the only Russian soldiers left in the center of Grozny are corpses and prisoners. The renovated Government buildings in the center of the city now lie in blackened ruins.

More than 3,000 Russian soldiers, by both Russian and Chechen estimates, are surrounded in their barracks by the separatists. Many of the captors are teen-age boys with stolen guns who live at home with their parents. The Russian troops have almost no water, little food and no avenue of escape.

For a military that only a few years ago policed one of the modern world's most formidable empires, and remains the biggest in Europe, it is a humiliation that will be hard to live down.

''The soldiers I saw at checkpoints are puny creatures,'' said Mr. Lebed, the retired general who has traveled twice to the region in the last week after President Boris N. Yeltsin assigned him complete responsibility for resolving the war in Chechnya. ''The men had lice. They are not clothed properly. It is sickening.''

Russian soldiers routinely beg for their food in Chechnya. A loaf of bread will get almost anybody by a checkpoint. Throw in a bottle of vodka and a pack of Camels, and questions will be asked of nobody.

The Russian troops — who, as Mr. Basayev said this week, ''were left by their leaders in 1995 on the streets of Grozny to be eaten by dogs'' — are bitter and cynical.

They freely offer to sell their weapons to the highest bidder. Many now, regardless of rank, will openly state their belief that they have no stake in insuring that Chechnya remains a part of the Russian Federation.

''This is not a war,'' said one Russian Army battalion commander, Oleg Chapayev, after being evacuated from Grozny for medical treatment this week. ''This is a game of cat and mouse. It seems as if the rebels were guided to our positions. Their operation was a complete surprise for us. Lately we were told to avoid any actions that could derail the peace talks.''

The rebels always knew where the Russians were, because there are no secrets in Chechnya. A woman selling milk at a market happily opens her vest to show the green sticker of the lone wolf, the symbol of the Chechen fighter. Toothless old men cheer on the streets as separatists race by in stolen cars. Boys hardly old enough to read scream, ''Allah Akhbar!'' — God is great — at every passing car. All Russians are hated.

Chechen and Western officials say the rebels have had financial help from rich supporters in Turkey, Jordan, Azerbaijan and Saudi Arabia, in addition to Russia itself.

Most of the backers in Russia are Chechen expatriates who have flourished by trading real estate and commodities and by running protection rackets in Russian cities.

But most of the weapons have been captured from the Russian forces. In the last year, as the Chechen leadership, including the military chief of staff, Aslan Maskhadov, watched angrily as Russian promises of peace talks and treaties dissolved into new bombing raids, they began to arrange to purchase weapons on the black market.

Most of the arms originated with units demobilized by the shrinking Soviet military, say Russian and Western analysts and the Chechen leaders themselves.

The Chechens were aided in this effort by ''donations from our foreign friends,'' said Akhmed Zakayev, one of the rebels' top commanders, and others. ''Boris Yeltsin can get billions of dollars of aid from the West,'' Mr. Zakayev said. ''And we are bandits for finding money to fight back.''

One of the first places the rebels seized in beginning their latest assault here was the militia post where, they knew, hundreds of weapons were stored along with tons of ammunition.

And Mr. Basayev gave strict orders in the last week to shoot only at the tires of armored vehicles, so the rebels could use them.

Earlier this year, the war intensified rapidly. The fighting restarted after Chechen guerrillas took hundreds of hostages from a hospital in the neighboring republic of Dagestan and escaped through Russian lines with many of them, and the Russian Army trapped the rebels in a border village called Pervomayskoye and tried to annihilate them.

By April, when Mr. Dudayev was killed in a Russian air raid, months of bombing had left the Chechens without much alternative or hope, and peace talks began to look like a way to gain time and a respite from the war.

Mr. Yeltsin said publicly that he could not win re-election without resolving the war in Chechnya. Both sides were desperate for a break from the grueling 20-month conflict.

So, without even discussing the fundamental issue of independence from Russia — the real purpose of the fighting — both sides entered into what many felt were the first promising peace talks since the war began.

Most separatist leaders have tempered their demands in the last six months. They no longer insist that the republic be completely independent of Russia, only that all troops be withdrawn and that free local elections be permitted to decide the region's fate.

The hopes for peace peaked on May 27, the extraordinary day when the Chechen separatists' president, Zelimkhan Yandarbiyev, met with Mr. Yeltsin in the Kremlin. He then watched as the Russian leader made his first trip to this region the next day to tell his soldiers, ''You boys have won.''

It was an obvious campaign stunt, but one that would have been impossible six months before. For many, including Mr. Basayev, it was an appalling spectacle, but it also seemed possible that Mr. Yeltsin was preparing to declare victory and pull out.

The History: Czars and Stalin, And Then Yeltsin

Like many Russians, the separatists felt that Mr. Yeltsin had tired of the war. And despite their hatred for him, they believed that he offered a better chance of peace than would his Communist opponents. To most Chechens, the day in 1944 when Stalin's Communists deported the entire Chechen nation to Kazakstan and Siberia — killing as many as a third of them in the process — remains their darkest memory.

Yeltsin said he needed to bring peace to Chechnya to win. We decided to believe him, and we postponed our operations. It was a mistake.''

After the election, it became clear that no peace was at hand. Russians refused to dismantle their checkpoints, as they had promised in peace meetings, and the rebels continued to kill as many soldiers each night as they could.

The failures of the last two years are nearly identical to those in the wars Russia has fought in this critical part of the world, where the West and East meet, for hundreds of years.

For Russia, conquering the Caucasus has always been a desire born partly of a deep romantic obsession with the breathtaking mountain region dating from czarist times — Pushkin, Lermontov and Tolstoy all wrote about it — but also of the absolute fear that Russians have of the Chechens' unswerving devotion to freedom at any cost.

As has been the case in the last year, when village after village has been bombed, the resistance to Russian rule was so great here at the beginning of the 19th century that the Russian general Aleksei Yermolov made it a routine practice to destroy entire settlements in retaliation for the death of any of his soldiers. This is a story that nearly every Chechen knows and many can cite by heart.

''They think we have always needed to kill them,'' said a young Russian soldier named Aleksandr, who was commanding a particularly jumpy checkpoint on the southern edge of Grozny this week. ''The Chechen people suspect us of fearing them so much we need to destroy them. And I think, basically, they are right.''

The Prospects: Peace May Now Be Best Option for All

Peace may be the only option left for Russia. This week the rebels circulated leaflets promising their trapped opponents that if they surrendered they would not be harmed.

To take Grozny back would cost Russia many more men, and the prize would be a city so completely in ruins that it would take years and billions of dollars to put back together again.

For the people of the city, who must now rely on relief trucks driven by rebels to deliver their canned milk, bread and vegetables each day, the war is not just part of their life, it is their life. Tens of thousands of refugees have fled in the last two weeks, but many others have remained.

''Where would we go?'' asked Larisa Butilova, who lives with her elderly father in an apartment building with no doors, windows, light or running water. ''This is the only place we have ever lived, and we have lived through something very bad. We are not waiting for it to get better or thinking it will get worse. We are just living here because this is our life.''

Soon the harsh winds of winter will sweep across the foothills from the mountains. Fresh food will disappear, and water will be even harder to find than it is now. The hospitals are without even the most basic medicines, and many relief workers have been driven from the city.

''I think the Russian side has finally realized that something has to happen now,'' said Rizman Lorzanov, a rich Chechen businessman who has donated his sprawling house about 15 miles south of the city for peace talks between the sides. ''If for no other reason than many of their soldiers will starve if nobody finds a way out.''

It was in the broad courtyard of Mr. Lorzanov's home this week that Mr. Lebed met with his Chechen military counterpart, Mr. Maskhadov. ''I think they both realized that they need to move this forward,'' Mr. Lorzanov said one afternoon. ''Obviously they are both proud men, but they are realistic.''

Most of the Chechens' hopes are now with Mr. Lebed, the man who from the first said this conflict would end in disaster for Russia. He has set at least two public goals for himself since becoming a member of the Yeltsin administration. The first is to succeed his boss as President; the other is to end the war. He seems unlikely to win the presidency if he cannot fulfill the other goal.

Russian soldiers have also largely placed their hopes in Mr. Lebed, because they believe that nobody else cares enough to end the conflict. And in Grozny, where cynicism about Russia has a long and well-deserved place, most rebel fighters say they are willing to give a chance to the man who has praised their courage– as long as they control the city.

''Lebed is a Russian,'' said Mussa Guysamo, a young fighter working in the brigade directly commanded by Mr. Basayev in the center of Grozny. ''But he is a fighter. And a fighter knows when he has lost.''