Holy water is water that has been blessed by a priest. Thus, holy water contains the residual touch of divine power, and so is always used in religious ceremonies when appropriate. Holy water is also efficacious against creatures steeped in evil, such as undead and creatures from the lower planes.
Note that not all deities use water as their holy element. Deities representing other elements may use those -- for instance, a priestess of Gaiya would carry a sack of holy earth. Still others may use alternate substances -- Painters dedicated to Losyera can bless their pigments to function similarly to holy water.