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If you mean the kind of holy water you find in the original Neverwinter Nights, then it, as well as the dragons blood and fairy dust, is used to upgrade weapons. A guy named Marrok in the basement of the arms shop in the Core district of Neverwinter can do this for you.
If you have Shadows of Undrentide, then it introduces an new kind of holy water in blue bottles. These are a kind of grenade weapons you can throw in combat and does damage to undead.
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