Graymouse
Pro Adventurer
I actually explained this to someone on YouTube because the body language didn't match with the English script.
Cloud actually said, "Fancy?/Dress up?"
Tifa backs up a little because she was conscious of herself and was shy at him looking at her in not such pretty clothes. She replies in Japanese, something like, she can make herself look good if she tries.
It wasn't about her fearing his rejection, but she was embarrassed about not having nice clothes.
My line of thinking was that she was really shy to have Cloud look at her "dress" up in those type of cloths.
Edited to add, I am not saying that Cloud is objectify Tifa. Also, it was Tifa who was asking Cloud on a date. I think that had something to do with her body language as well.