When you get to the point where you pick a partition in WinXP Setup, you're given the following options:
Format NTFS
Convert to NTFS
Format FAT
Leave it as-is.
I highly recommend trying to convert first. If the drive is too full, then back the data up on another drive and give it a clean sweep.
Just so you know: If your drive is hooked upto an ATA100/ATA133 controller on a PCI card, or on a controller like on the Asus A7V (4 IDE ports instead of the normal 2), then I highly recommend that you hook the drive up to an ATA66/33 controller on the board instead. If your motherboard only has two IDE interfaces, then you won't have to worry about this. Basically, the reason I say this is that sometimes Win2k or XP setup can go nutty (ie: refuse to detect critical dll files when it detects your devices, or flat out refused to recognize your hard drive). Sometimes it works, sometimes it doesn't. This is just a problem I noticed when installing both 2k and XP on my A7V, because of the way the ATA100 controller is wired up. The Linux-Mandrake installer has this same problem. Like I said, if your board only has two then don't worry about moving cables.
The reason why I recommend that you go for NTFS is because its far more reliable, far more secure, and it will increase the overall performance of the OS. Like Icefire said, once you go NTFS, you'll never have to see that blue chkdisk screen ever again. (This is due to the journaling feature of the file system.)
You CAN leave it FAT32 and convert later if you want if you're not sure about it mucking up your data.