Very interesting, I had the exact same trouble as you were describing, while running Win 98 SE as well (600 Mhz). There would be a 20-30 second halt in performance of the computer whenever I...
1. Started the program
2. Initiated a connection from the login menu.
3. Right-clicked on a file in the file manager.

...that was with version 3.42 (800KB), which I assume was a compressed version. However, per your advice, I also downloaded and installed version 3.5, with which all of the above problems have completely gone away!
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There is something strange going on with the compressed executable of WinSCP. My computer (Windows 98 SE, 1.4 GHz AMD Thunderbird) freezes up totally for about 30 seconds when I press the "Login" button in the login window. Then, after about 30 seconds, the program logs in and works mostly OK. But not totally OK, because clicking a file name with the right mouse button also freezes up the computer, but only for about 15 seconds.

By "freezes up" I mean that everything stops. For instance if Winamp is playing an MP3, it stops. Mouse cursor doesn't move. Etc.

This has been a big nuisance for me when using WinSCP, and has happened with every version from 2.3 to 3.5.

However, today I decided to try out the installer. I installed version 3.5 using the installer, and was pleasantly surprised when WinSCP logged in without any delay. And the right mouse button brings up the context menu without any delay.

So, from now on I will use the non-compressed exe file, and WinSCP will be an even better program than before. If somebody else is having similar problems, I hope this helps.