CHARGES of political favoritism in the awarding of contracts worth millions of dollars, and further charges of conflicts of interest and incompetence, are shaking the upper echelons of the District government. Jose Gutierrez, the city's Administrative Services Department director until this month, has said he was removed because he resisted pressure from City Administrator Thomas Downs to award lucrative contracts to political allies of Mayor Marion Barry. The Barry administration has contended that Mr. Gutierrez was incompetent and may himself have been involved in conflicts of interest in awarding contracts. Mr. Gutierrez has been demoted to a relatively low-level job in the city's planning department.

The Barry administration has not previously faced such serious charges from a city official of Mr. Gutierrez's stature. A Barry insider has not previously fallen into disfavor so precipitately. The city's increasingly vocal Hispanic community, incensed at what its spokesmen call unfair treatment of Mr. Gutierrez, has called on the federal government to investigate possible discrimination against Hispanics in employment in the awarding of contracts and in providing social services.

It has all developed into a nasty dispute; it could get nastier. Fortunately, the matter has been handled so far by city officials in a way calculated to retain the public's trust. Two D.C. Council committees are to look into Mr. Gutierrez's allegations that he was pressured to award contracts to the Chesapeake & Potomac Telephone Co. to replace the District government's telephone network because some high-ranking C&P officials are political allies of Mr. Barry.

A panel appointed by the mayor will now determine what telephone network the city government needs and which firm should get the contracts. Mr. Barry has also instructed his legal counsel to investigate whether Mr. Gutierrez may have decided to authorize the city to enter a $22.4 million lease agreement to a Hispanic businessman in exchange for some favor.

It is important to note that Mr. Gutierrez has so far come forward with no proof to substantiate his allegations. It will be up to the council, at least in the first instance, to investigate whether contracts were placed by political allegiances. The awarding of contracts worth $20 million to replace the District government's telephone network and 911 emergency system need to be handled in a manner beyond reproach.