In a major change in U.S. Middle East policy, Secretary of State George P. Shultz announced yesterday that the United States is ready to begin a "substantive dialogue" with the Palestine Liberation Organization and authorized the American ambassador in Tunisia to "make himself available" for contacts with its representatives.

Shultz acted a few hours after PLO Chairman Yasser Arafat in Geneva declared in the most direct language he has ever used that the PLO has accepted Israel's right to exist.

"The Palestine Liberation Organization today issued a statement in which it accepted U.N. Security Council Resolutions 242 and 338, recognized Israel's right to exist in peace and security and renounced terrorism," Shultz told a hastily summoned news conference last night. "As a result, the United States is prepared for a substantive dialogue with PLO representatives."

President Reagan in a White House statement last night said he had authorized the Shultz decision. Shultz added that President-elect George Bush had concurred.

Bush spokesman Stephen Hart said, "the vice president feels that Arafat met the conditions and he supports the decision."

Reagan's statement said the PLO "must demonstrate that its renunciation of terrorism is pervasive and permanent."

The president also said the U.S. special commitment to Israel's security and well-being "remains unshakable. Indeed, a major reason for our entry into this dialogue is to help Israel achieve the recognition and security it deserves."

However, the Israeli Embassy here immediately issued a statement saying, "We regret the U.S. decision to establish contact with the PLO. We do not consider that this step will advance the peace process in the Middle East.

"Israel will pursue its policy of searching for peaceful solutions to the conflict through direct negotiations with Palestinian Arabs and with Jordan," it said.

The U.S. decision is certain to provoke a storm of protest from the American Jewish community and Israel's supporters in Congress, and to confront the incoming Bush administration with a major foreign policy controversy. Only a few days ago, Israel's supporters had applauded Shultz for refusing to allow Arafat to address the United Nations in New York because, as Shultz said then, Arafat "knows of, condones, and lends support" to terrorist acts.

But Reagan last night called a U.S.-PLO dialogue "an important step in the peace process" and said it represented "the serious evolution of Palestinian thinking toward realistic and pragmatic positions on key issues."

Both Reagan and Shultz said the U.S. objective was not just to open a dialogue with the PLO but also to achieve direct Arab-Israeli negotiations in pursuit of a "comprehensive Middle East peace."

"In that light, we view this development as one more step toward the beginning of direct negotiations between the parties, which alone can lead to such a peace," Reagan said.

Shultz stressed that the U.S. action did not "imply an acceptance or recognition by the United States of an independent Palestinian state," as proclaimed by the PLO in Algiers last month.

U.S. Jewish organizations reacted initially with caution. The B'nai B'rith Anti-Defamation League said, "We must watch to see whether the PLO will match words with deeds." The American Jewish Committee called the U.S. decision "a potentially very serious development . . . so it is necessary to be cautious and realistic about opportunities for advancing peace."

Shultz said that U.S. Ambassador Robert H. Pelletreau in Tunis, where the PLO has its main headquarters, would be the sole U.S. official authorized to deal with the exile group.

"The first item of business will be the subject of terrorism," Shultz said. "We'll make it clear that the renunciation of terrorism is essential."

Shultz asserted repeatedly that the decision represented no change in what has been U.S. policy since 1975 when then-Secretary of State Henry A. Kissinger promised Israel that the United States would not deal with the PLO until it recognized the Jewish state's right to exist and accepted the two U.N. resolutions. The Reagan administration later added the condition about renouncing terrorism.

"I didn't change my mind," Shultz said in response to questions about why he was taking this position after rejecting several statements by the PLO and Arafat in the past month as inadequate.

"They made their statement clear so it doesn't have ambiguities that allow different people to make different interpretations," Shultz added.

He said he did not know what might develop out of the dialogue and noted that the Reagan administration was about to leave office. "This is basically something for the next administration," he said.

Asked whether he believed Israel now should deal with the PLO, Shultz replied: "Israel always has made it clear that the U.S. conditions are not necessarily theirs. It's totally for Israel to make its own decisions and there is nothing to be inferred judgmentally about what they should do."

Shultz's decision came after two hectic days of lobbying by key Arab allies of the United States, notably Saudi Arabia and Egypt. Saudi King Fahd sent two personal messages to Reagan yesterday saying Arafat had gone as far as he could and the United States should not miss this "historic opportunity."

The Saudi ambassador, Prince Bandar bin Sultan, and Egyptian Ambassador Abdel Raouf el-Reedy pressed the White House and State Department to respond positively.

White House spokesman Marlin Fitzwater said the chain of events that brought about last night's surprise announcement began Dec. 2, when the United States was notified that Arafat would visit Stockholm Dec. 6-7 and would speak clearly to the U.S. conditions for opening a dialogue.

On Dec. 3, Fitzwater said, the United States sent to the Swedish government precise language for Arafat to satisfy U.S. conditions.

On Dec. 7, Sweden told the United States privately that Arafat planned to publicly meet the U.S. conditions after talks with a delegation of American Jews.

That triggered intense administration discussions, culminating in a decision by Reagan while he was in New York to meet Soviet President Mikhail Gorbachev. Reagan authorized Shultz to open a dialogue if Arafat met the U.S. conditions.

But Arafat's Dec. 7 declaration fell short of the mark, and Shultz at a news conference in New York said the PLO still had "a considerable distance to go."

The Swedes persisted, sending Washington on Friday night the draft text of what Arafat planned to say in Geneva about the U.S. conditions. The United States was told the language had been approved by the entire PLO executive committee.

U.S. officials said Shultz sent a written commitment to Swedish Foreign Minister Sten Andersson that the United States would immediately begin a "substantive dialogue" with the PLO if Arafat delivered the draft unchanged.

Andersson then assured Arafat of the U.S. commitment.

Shultz on Monday ordered aides to inform Israel of the impending U.S. move to lessen the shock.

But again, Arafat's statement to the special U.N. General Assembly meeting in Geneva fell short of U.S. specifications.

Yesterday, the United States received word that Arafat might still meet the U.S. requirements. After intense White House and State Department discussions throughout the day, Reagan reaffirmed his willingness to authorize a dialogue should Arafat become explicit.

Shortly after 3 p.m. yesterday, a U.S. diplomat in Geneva telephoned the State Department and played a tape of Arafat's statement, so it could be discussed.

About 4 p.m. Shultz told the White House that Arafat had finally met the U.S. conditions, White House and State Department sources said.

Bush was briefed, and shortly after 5 p.m. telephoned Reagan and joined the consensus. Reagan then officially authorized the announcement made by Shultz at the State Department at 6:30 p.m.

Staff writers David Hoffman and Don Oberdorfer contributed to this report.