Windows XP can be installed on either a FAT32 or NTFS partition. If you choose to install on FAT32 initially, you can convert the partition to NTFS at a later time. Details here
. You will not lose any data.
It sounds like the problem here however is converting a FAT16 partition to FAT32. This was possible with the Windows 9x operating systems (95, 98 including SE, and ME) but is not possible with Windows XP. The only way to do it on an XP system is to use a third party tool like Partition Magic. More info can be found here