You may find some help at Microsoft Advanced Search. Selecting product "Windows 98" and using "Compressed Drive" as a search string brought up quite a lot of stuff. Sort of a nostalgia trip remembering how crude Win98 was/is.

You didn't say what compression method you used, but if it's the "Drivespace" or "Doublespace" compression that's built in for Win95 and Win98 it would appear that the compressed drive shouldn't prevent you from reinstalling Win98. If you used an aftermarket drive compression the situation may be a little more ambiguous.

With product "Windows 98" and search "Compressed Drive Reinstall" at the above link I find:
Windows 98 Setup.txt File: Article 179756 which is the same file that should be on Win98 standard edition install/setup disks. The file on your disks may be a little different if you have Win98SE, but shouldn't differ too significantly on the problems you have.

This is a rather long document, mostly dealing with how to update from Win95; but if you scroll down far enough in the above file, to "IF YOU HAVE A COMPRESSED DRIVE" there are several problems that can be encountered, but there seem to be fixes or workarounds for most of them. The biggest problem appears to be lack of sufficient space on a compressed drive, but moving enough stuff to make the required space should be a lot easier than backing off everything. Ideally, if you have an uncompressed partition you should install there, but you should be able to install on your C:\ drive if you can make enough space.

Three problems that you may have to work around that I don't see in this file:

1. Compressing your hard drive, or converting to FAT32, usually removes the Win98 uninstall files, so your removal may have caused some unpredictable effects.

2. If the drive was compressed by Win95, and you upgraded, there will likely be a couple of "obsolete" compression drivers in C:\ root. Win98 creates new drvspace.bin and dblspace.bin files in C:\Command, and only the new ones are updated. If you make a startup disk, it will probably copy the old ones from C:\. You just need to copy the "good" ones from C:\Command to C:\ and make a new startup disk. Look at Err Msg: The Compression Driver Cannot Be Set Up Correctly: Article 187218 for info on this.

3. The drive compression is a DOS program and can only "read" files for which the total file length plus path is less than 66 characters. Windows can use longer ones, so you may have some. If you're trying to install in DOS, you may need to "shorten some paths." Err Msg: Drive C Contains Errors That Must Be Corrected: Article 132883 gives details on how to use ChkDisk to get this done.

Before you get done, you may want to refer to Troubleshooting DriveSpace in Windows 95: Article 133175. Although the article says it applies only to Win95, the link that found it for me, in How to Determine If a Hard Disk Is Compressed: Article 193051 says that it also applies to Win98.

John