Because at the time of Windows 98, the only formats that
Windows 98 understood were FAT16, and FAT32. FAT16 is
even more restrictive compared to FAT32, so it's really
the lesser of two evils.
XP can use NTFS (NT File System, used by the NT line of
OS's such as NT 4, Windows 2000, XP, and Windows Server
2003). This file system is much much more efficient at
high capacities compared to FAT32, and has other benefits
as well.
The only real reason to use FAT32 is if you are dual-
booting between XP and Windows 95/98/ME, otherwise at
anything above 16-20 GB or so, NTFS is vastly superior.