Xenogears is better than Final Fantasy VII on just about all levels.

Story: Xenogears is infinitely superior. Period.
Graphics: The cutscenes are about equal. FFVII has better backgrounds than Xenogears but FFVII has some of the worst standard character graphics I've ever seen (block people!?). I'd say about a tie for this.
Characters: Just about every character in Xenogears has an expansive backstory and well-defined personality. Even Chu Chu ties in to the major plot. FFVII characters were much less compelling, and sometimes downright annoying.
Villains: Again, Xenogears is infinitely superior. Jenova was a decent bad guy, of course, but she simply can't beat Grahf, Id, Ramsus, Miang, and Krellian. And Sephiroth (ignoring the fact that he was a frozen corpse in the Great Crater for a moment) really wasn't that good. He killed Aeris and burned a village to the ground and failed at crushing the planet with a big space rock. I don't care if he looks cool and has a massive sword, he doesn't hold a candle to Grahf who can take down an 18-meter gear with his BARE HANDS.
Gameplay: I honestly didn't like FFVII's system all that much. The materia was interesting, but it was nothing really special to me, and most of it was simply tried-and-true Final Fantasy format. I found the Deathblows and the Gear Combat to be far more entertaining. Also, Final Fantasy VII, as is common with most Final Fantasies, is really quite linear in where you can travel. Xenogears uses a fully 3D world that can be interacted with, and the ability to jump adds whole new dimensions to the gameplay. Final Fantasy VII could easily have been a sprite game and still played through essentially the same. It doesn't do anything new besides mess with the viewpoint a bit so it looks more 3D (which often caused laughably bad angles).
Replay Value: The sheer size of Xenogears is immense, and the extras and complexity of the story can easily make it replayable. Final Fantasy VII lacks that, it's a fairly linear storyline with very little plot twists, making it easily predictable and less fun to play through again.

In conclusion, Xenogears is far better than Final Fantasy VII.