Can the OS itself be installed in the FAT32 system?
Yes, it can. Depends on drive/partition size. However, this debate is totally off-topic here.
No it's not. I only brought it up since the person with the problems said his drive was FAT32. I still think it's possible that it might be the root cause of his problems. Is Avast!5 fully compatible with FAT? It does not say it can be used by versions of Windows that were made for that file system.(versions prior to Windows 2000)