AUSTRALIAN Prime Minister Paul Keating has written to the Prime Minister of Malaysia, Datuk Seri Dr Mahathir Mohamad, to say he did not intend to offend him when he called the Malaysian leader ''recalcitrant''. The remark provoked an angry response in Malaysia. Mr Keating's letter said the issue had been blown out of proportion and it was not in the long-term interest of either Australia or Malaysia for the squabble to continue, a statement issued by a spokesman said. But Mr Keating's bid to end the row with an explanation may not satisfy Malaysian government officials who have been demanding an outright apology, declaring he had ''humiliated'' Dr Mahathir by criticising him for not attending the Asia Pacific EconomicCo-operation (APEC) summit in Seattle. In the letter, Mr Keating said his remarks in Seattle were ''not calculated to give offence to Dr Mahathir''. ''Rather, they were made to make clear that it was a decision for Malaysia and Dr Mahathir if Malaysia wished to absent itself from the APEC meeting and that Australia had clear design interests in the architecture of APEC, interests which it would defend vigorously,'' the letter said. ''The Prime Minister considers that this issue can only be settled if both countries are willing to put it behind them.'' In a television interview this week, Mr Keating sidestepped questions about whether he would apologise, saying Dr Mahathir did not require it and the criticism was part of the ''rough and tumble of life''. The letter stopped short of an apology but said Mr Keating valued Australia's relationship with Malaysia and wanted to build on it. Mr Keating said he accepted that on some issues Australia and Malaysia would not see eye to eye. The letter said: ''Both governments need to avoid a situation in which the media is setting the tone of the relationship. ''We hope that both governments will act in a way which clearly draws a line under what has happened and avoids any further deterioration in the relationship or any slide into tit-for-tat retaliation.'' The statement said the Malaysian Government had made no official protest to Australia and had taken no action to downgrade the relationship. But Mr Keating's letter reflects concern that the row is in danger of worsening. Malaysian government policy to date has been to apply maximum pressure on Australia for an apology while also keeping the Australians guessing over Kuala Lumpur's intentions. Defence Minister Najib Tun Razak foresaw relations between the two countries as moving into ''a very difficult period'' unless Mr Keating issued an apology. How far Malaysia would go if it decided to punish Australia further for its alleged humiliation of Dr Mahathir is hard to tell. But there was a strong indication in a warning by Mr Najib that Australia could face greater competition in penetrating Malaysian markets. Analysts recalled that during the early 1980s ''Buy British Last'' campaign, the Malaysian philosophy was to make Britain pay without seriously damaging Malaysia's interests. If adopted with Australia, it could mean Malaysia giving contracts to non-Australian companies where it did not disadvantage the Malaysians from a cost or quality standpoint. Apart from damaging Australian-Malaysian relations, Mr Keating's remarks - a knee-jerk reaction to prodding by the press - have provided Dr Mahathir with new evidence for his argument that Australia does not understand Asian values and cannot aspire to be a full-fledged member of the East Asian community, far less join the Association of Southeast Asian Nations Free Trade Area, as suggested by Thailand. Mr Keating's loss in terms of harm to his own image and Australia's standing in Malaysia and much of the region has undoubtedly been Dr Mahathir's gain.