You need CRM 4.0 Fetch method that takes "fetchXML" as the single parameter of an XML string to execute the query. The XML parameter you constructed builds the right fetch xml string as illustrated in your screen shot. This string will be passed to Fetch method of the Web services to obtain a result back. Both parameter and return result will be taken care of by SI Web Parts.
The issue at hand and why you are receiving error is that "RetrieveMultiple" does not accept an XML string parameter as "FetchXML". You would need to find the "Fetch" method exposed by CRM services and construct it. Otherwise, you would have to work with a strongly typed object as parameter to "RetreiveMultiple". From WSDL, the specific info on this type is not well known. We only know about its base type. It is not advised to use this method in SI Catalog definition unless you are well around CRM object API.
Make sure when you define Operation, from the method drop down list, you find "fetch" as I believe that is for "fetchXml" that allows you to construct an XML query parameter without knowing specific parameter type and shall work the best for you.