A chemical widely used on apples, peanuts and other produce will remain on the market for at least two more years while scientists try to clear up questions about its ability to cause cancer, the Environmental Protection Agency announced yesterday.

Last summer, the agency proposed banning the substance daminozide, sold by Uniroyal Co. under the brand name Alar. The EPA contended then that Alar, which breaks down into a chemical variant of rocket fuel when cooked or processed, posed an "unreasonable risk" of cancer to persons on an average American diet.

EPA officials said they backed away from a ban after industry groups argued that dietary exposure to Alar had been overestimated and an advisory panel of scientists faulted the tests showing that the chemical caused cancer.

John A. Moore, head of the EPA's pesticide division, said the agency would instead impose "interim" restrictions on Alar, such as reducing the maximum amount to be sprayed on orchards and discouraging use on apples destined for the processed-food market.

A Uniroyal spokesman said the company is pleased with the decision. "We continue to believe firmly in the safety of our product," company official John A. Lacadie said. "We're confident that the results of all tests will reconfirm our position . . . . "

The Natural Resources Defense Council, an environmental group, blasted the EPA announcement as a "textbook case of EPA inaction and corporate irresponsibility" and threatened to take the agency to court to force Alar off the market.

"The primary group of concern is children," council scientist Lawrie Mott said. According to the EPA, children may face two to nine times greater risk than adults because their diets tend to include more foods likely to contain Alar residues. Applesauce, apple juice and peanut butter were cited.

The EPA's Moore said "legitimate concern" exists about the effect of Alar residues on infants and small children. He said agency officials do not believe that children will face an unreasonable risk during the two to four years needed to gather additional data on Alar.

In any case, Moore said, the EPA would be "hard-pressed" to take the chemical off the market in light of questions raised by scientists on its advisory panel.

Alar went on the market in 1963, before pesticide law was tightened to require extensive health and safety testing. "If this were a new product, it would not be allowed on the market until the data were in," Moore said.

Alar kills no pests or diseases but is used to regulate growth and ripening of crops. It is used most heavily on apples, particularly Red and Golden Delicious, McIntosh and Stayman varieties, because it prevents premature fruit drop and produces a brighter, harder apple that withstands long storage.

It is also used on peanuts to produce a short, erect vine that makes digging peanuts easier, on Concord grapes to produce larger fruit and on peaches, pears, cherries, prune plums, nectarines, tomatoes and other vegetables to control ripening and enhance storage quality.

Agricultural interests have battled to save Alar, arguing that there is no substitute and that, without it, apples could not be marketed year-round. But environmentalists contend that the chemical is nonessential -- used mainly to save labor and improve cosmetic appearance.

"The benefits of this chemical are negligible," Mott said. "We're not talking about crop destruction or even reduced yields."

EPA officials said some food processors, notably baby-food manufacturers, had agreed to limit the use of Alar-treated fruits.

Some processors have gone beyond that, however. In late 1984, eight months before the EPA announced that it was considering a ban on Alar, the National Grape Cooperative, which produces about half of the nation's Concord grapes and supplies the makers of Welch's grape juice and jellies, ordered its members to stop using Alar.

James Weidman, a spokesman at the cooperative's Westfield, N.Y., headquarters, said that there "were some questions about the chemical" and that Welch's wanted to protect its products from a possible adverse consumer reaction.

Asked if the ban has been a problem for the growers, he replied, "No, it hasn't turned out to be."