The State Department said yesterday that El Salvador continues to make progress toward achieving democracy, citing in particular President Jose Napoleon Duarte's efforts to end the civil war through his "historic offer of a dialogue with the guerrillas" fighting his government.

In its quarterly report to Congress justifying U.S. aid to the strife-torn Central American country, the department said:

"El Salvador is undergoing a political transformation from a nation in which democracy has been absent for decades to one in which the people are able to determine freely who their leaders will be and whose decisions cannot be overrruled by otherwise powerful sectors of society."

The report, which covers Sept. 1 through Nov. 30, asserted that the Duarte government has been making steady progress in expanding democratic electoral processes, curbing political murders and other human rights abuses, stabilizing the war-shattered economy and improving the Salvadoran armed forces' ability to "defend the people and national infrastructure from a destructive guerrilla insurgency."

But the report reserved the major share of praise for Duarte's bold gesture in going unarmed to meet with guerrilla leaders at the town of La Palma on Oct. 15. It said:

"That President Duarte was able to meet with the guerrillas and lead his government to those talks reflects the dramatic change that has taken place in Salvadoran politics. While rapid progress is not considered likely, the established dialogue clearly holds out reasonable prospects for the peaceful resolution of critical issues and, hopefully, for the eventual reincorporation of the insurgents through electoral process."

However, it accused the guerrillas of pursuing a "hard line" during a second round of talks on Nov. 30 and cautioned, "It is now clear that the initial euphoria which greeted Duarte's initiative has been dampened by the guerrilla posture at the second round of talks and replaced with a more realistic appraisal of the long and difficult process ahead. . . . Nevertheless, its initiation crossed a threshold of enormous significance."

The State Department reports on El Salvador began in 1981 when Congress required them every six months as a condition for continued aid. The requirement expired last year, but President Reagan said he would continue to provide the reports voluntarily and did so last January.

In July, Congress again made the reports mandatory, this time every three months. In each report, the State Department has found progress in human rights, land reform and democratization, but its conclusions have been challenged repeatedly by human rights organizations which charge that abuses by the military and rightist forces continue.

On the human rights question, the report released yesterday said "death squad" killings had declined during 1984. It said that in 1980 political murders numbered more than 800 a month. In 1981, the figure was 444 per month; in 1982, 219 per month; in 1983, 139 per month. This year, the report said, political murders averaged 88 per month from January through June.

On another sensitive issue -- the investigation and prosecution of those involved in the murder of U.S. citizens -- the report conceded that the Salvadoran courts had sustained dismissal of charges against an army officer, Lt. Rodolfo Lopez Sibrian, "despite strong evidence against the suspect." Lopez Sibrian was implicated in the 1981 murder of two U.S. labor advisers.

But it contended that the Duarte government had "argued strongly" against the court's decision, had ousted Lopez Sibrian from the armed forces and was trying to build cases against suspects in other cases where American citizens were murdered.