The D.C. Public Service Commission approved yesterday a 20 to 30 percent reduction in Centrex service rates sought by Chesapeake & Potomac Telephone Co. in an effort to make the company's offerings more attractive to large customers, including the District government, which plans to install a new telephone system.

The PSC ordered slightly higher rates than those sought by C&P for the Centrex service, which provides businesses with a private telephone network that is handled by the phone company for a monthly fee.

It also told C&P that large private or government customers with more than 10,000 telephone lines would have to sign five-year contracts for the Centrex service, rather than the three-year contracts proposed by C&P.

C&P officials said yesterday they could not comment on the ruling until they have had time to study it. In previous testimony, the company said its proposal for decreasing Centrex rates was "just and reasonable" and "necessary to prevent a substantial loss of Centrex customers."

Centrex service is in hot competition with technologies made by Rolm or International Business Machines Corp., which allow companies to construct their own telephone networks. PBXs, the latest telecommunications devices companies can install on their own premises, allow businesses to transmit both high-speed data and telephone conversations over telephone lines and allow businesses greater flexibility.

About 40 percent of C&P's 782,351 telephone lines in Washington are on the Centrex service, according to C&P.

C&P officials are seeking several telephone contracts with the city, including one to install phone service in the new D.C. municipal office building at 14th and U streets NW. The company requested a reduction in its Centrex rates to enhance its bid.

City Administrator Thomas Downs has said he will receive a recommendation Friday from the Department of Administrative Services on how to proceed with selection of a company to install 800 to 900 telephones in the new center, but probably will put off for two years a final decision on a new government-wide telephone system.

C&P's Centrex service wont be fully "digital" until 1986, at which time the system will be able to efficiently process both data and telephone calls.

Currently, the Centrex system can only transmit data at high speeds with additional technology. This limitation is leading many companies and the General Services Administration to install private networks.

C&P's effort to win the D.C. government contracts is one of the issues in a growing controversy over whether the District awards contracts for political reasons.

Jose Gutierrez, former director of the Department of Administrative Services, charged recently that Downs had attempted to steer the contracts to C&P as a favor to Delano Lewis, executive vice president of C&P and a longtime political supporter of Mayor Marion Barry.

Downs and Barry have denied the allegations. Last week, Barry demoted Gutierrez to a lower post in the D.C. Planning Office in retaliation.

Thomas J. Mattingly, a former communications specialist who was hired by Gutierrez, said that he argued within the administration that a digital PBX system would be more versatile and cheaper in the long run .

"Centrex is not now covering its true costs," said a spokeswoman for the D.C. Office of the People's Counsel. "They [C&P] are losing money on the service now . . . . To decrease still further rates for Centrex means the service will have to be subsidized by other classes of customers."