Well, I dont have a Pavilion but I have a Brio and I guessing all HP computers and their recovery discs will behave in the same way. So, if you were to use the Recovery method that HP recommends and provides for, then yes, it will delete everything on your HDD and reset everything to the factory defaults. All of your data would be lost, if the Pavilion behaves like the Brio. Your safest bet would be to disconnect the hard disk, take it to a friend's place and offload it to either his hard disk or a DVD+RW (that is, if your computer didn't come with one) and then use the tool on your computer to reset the computer to the factory defaults and then recopy all your data back to it. (I don't suppose they still provide a separate Windows XP disc, do they? Its all bundled in the same recovery tool, isn't it?)
Anyway, before you take drastic measures, do explain the problem in detail and what happens when you try to download something from the Internet. Do you get an error, data corruption, etc. Also, please download HijackThis from here, run it and paste the log file it creates back here in this thread, so we can take a look it spyware/viruses are indeed causing this problem. You can download HJT here:
http://www.spywareinfo.com/~merijn/downloads.html
Also, please refer this excellent tutorial on using HJT, if you're ever unsure of as to what to do:
http://www.thinkdigit.com/forum/viewtopic.php?t=15729