The White House avoided a constitutional confrontation with Congress yesterday by agreeing to allow members of a House subcommittee to review Interior Department documents previously denied them under executive privilege.

The Reagan administration, under increasing fire from Congress for withholding information, had sought to make the issue a test case, but decided to compromise after the House Energy and Commerce Committee voted two weeks ago to cite Interior Secretary James Watt for contempt of Congress.

Committee members said the White House, aware of Watt's unpopularity on Capitol Hill, feared that the contempt citation might well pass on the floor of the House. Had that occurred, Watt could have been brought to trial in U.S. District Court, or arrested and tried by the House itself. Conviction carries a fine of up to $1,000 or a jail sentence of up to 12 months.

"We don't want the confrontation," said White House counsel Fred F. Fielding, who added that the agreement "is not a precedent for either party. We stepped back a little, and certainly the House stepped back a little."

Committee Chairman John D. Dingell (D-Mich.) said the compromise "continues the principle that Congress is entitled to any document in government anywhere." He decided to avoid a floor fight, he said, because "Congress is busy" on other matters.

Under the agreement, the White House will deliver the seven documents in question--all relating to Canadian energy policy as it applies to U.S. companies--Thursday at 9 a.m. The 17 members of the oversight subcommittee would have four hours to read and take notes on them, but would not be permitted to show them to staff or to Xerox the approximately 25 pages. At 1 p.m., the White House would retrieve the documents.

The documents were requested last August as part of an inquiry to determine whether the United States should retaliate against Canadian restrictions on U.S. companies holding Canadian mineral leases. U.S. law requires "reciprocity": foreign corporations cannot lease U.S. mineral lands unless U.S. companies get equal treatment in the foreign companies' nation.

While Watt provided most of the 200 documents originally requested, he claimed executive privilege on 31 items, saying that they involved "sensitive materials bearing on foreign policy." After considerable pressure, he relented on all but seven or 11 (the precise number is disputed, depending on how the documents are divided), mostly dealing with discussions before the Cabinet Council on Economic Affairs.

"There was nothing sensitive in these documents," said Rep. Marc L. Marks (Pa.), ranking Republican on the subcommittee and the only GOP member to vote for the contempt citation. "Watt would have given over the papers had the White House not intervened. They were being obstructive just to be obstructive. Politically, this is the one of the most asinine things they've pulled to date."

Although there have been other subpoenas for administration documents, the Watt contempt citation was the farthest that any confrontation has gone in the Reagan administration, and the most serious confrontation since the House Intelligence Committee voted in 1975 to cite Secretary of State Henry A. Kissinger for contempt. The Kissinger matter was resolved hours before it was to be voted on the floor.

The Watt affair, Democrats charge, is part of a "pattern of obstructionism" by Reagan officials who have withheld documents from other committees, including Judiciary and Government Operations, have refused to allow middle-level government officials to discuss policy with congressional staff, and have declined to send pertinent witnesses to hearings.

In one recent hearing with Watt, a subcommittee chairman, Rep. Toby Moffett (D-Conn.), asked what he would get if he asked for documents on the new wilderness policy. Watt replied, "I'd send you a news release."