The Air Force has agreed to pay $160,000 to Leonard P. Matovich, a former Air Force sergeant who was booted out of the service in 1975 after he publicly admitted he was a homosexual. In return, Matlovich gave up his five-year crusade to gain readmittance to the Air Force in a landmark gay rights case that challenged the military's ban on homosexual servicemen.

Air Force officials said yesterday the settlement "should have no effect" on the military's policy of excluding avowed homosexuals from military service. Gay activists immediately vowed that they would step up their efforts to get the ban overturned through other test cases.

"We continue to regard homosexuality as fundamentally inconsistent with military service and wanted to avoid returning Matlovich to active duty," Air Force Secretary Hans Mark said in a prepared statement yesterday explaining why the Air Force agreed to make the payment.

Calling it a "half-victory," Matlovich, a Bronze Star Vietnam War veteran with an unblemished military record, said Ronald Reagan's election as president and the conservative Republican takeover of the U.S. Senate convinced him to end the fight. He said that by the time his case would have reached the U. S. Supreme Court, the high court probably would be dominated by conservative appointees of Reagan and former President Richard Nixon, making chances of a pro-gay decision virtually impossible.

"It was a harder decision to quit the case than it was to begin the case," Matlovich, 37, said in a telephone interview from San Francisco, where he now works as a car salesman. He said the $160,000 payment is "an admission on the part of the military that they had done me wrong." He said he will use the money to promote the cause of gays.

The settlement agreement give Matlovich $98,000 in compensation beyond the $62,000 in back pay and fringe benefits the Air Force says he accumulated since his dismissal.

Matlovich's lawyer, Patricia D. Douglass, said nearly all of the $62,000 probably will be taxable as ordinary income, but she believes the rest of the payment is not taxable. It was not immediately clear whether any of the branches of the armed forces might now have to make similar payments to other gay servicemen who have been dismissed from the military.

In the settlement agreement signed by attorneys for the Air Force and Matlovich, the government maintains that Matlovich's dismissal was legal and that the government had no liability to him, despite his claims that the firing resulted in personal harassment, loss of his privacy and damage to his reputation.

Franklin Kamenv, a prominent District of Columbia gay activist who helped engineer Matlovich's challenge, said he greeted the decision with "mixed feelings" when Matlovich told him the news on Sunday. "If it had ended with a clear-cut victory . . . I would have been delighted," Kameny said yesterday.

Kameny said gay rights activists plan to step up their assault on the military's ban against homosexuals. "The battle will heat up, not cool off, as a result of the settlement in this case," Kameny said, adding that a task force of gay military and legal experts has been formed to help gay servicemen challenge the prohibition. He said the military is going to be forced to spend increasing amounts of money in administrative and court hearings "until the policy of excluding gays is reversed."

The issue of whether it is unconstitutional for the military to exclude gays -- the main reason Matlovich began his challenge -- still remains unresolved.

Air Force regulations prohibit the retention of homosexual servicemen unless "the most unusual circumstances exist" and the Air Force has said that it has never found reason to allow a gay serviceman to remain in the military.

U.S. District Court Judge Gerhard A. Gesell upheld the Air Force's ouster of Matlovich in a July 1976 ruling, saying that there was no constitutional right to engage in homosexual activities.

Later, the U.S. Court of Appeals here ruled that the Air Force had not properly defined the various exceptions under which a homosexual serviceman could remain in the service and why Matlovich did not qualify. The appeals court did not address the constitutional issue and sent the case back to Gesell for an explanation from the Air Force on its policy towards gays.

After the Air Force filed several contradictory statements on its homosexual policy, Gesell on Sept. 9 ordered that Matlovich be "promptly reinstated" because the Air Force had engaged in "perverse behavior" in failing to explain when it retains homosexuals in the service and when it does not.

Matlovich would have reentered the service Dec. 5, a date the Air Force claims could not have been postponed while it appealed Gesell's order.

Douglass, Matlovich's lawyer, said she believes the Air Force's inability to define its standards for homosexuals will help other gay servicemen who challenge the regulations in the future.