In the water-and-Spirit rebirth that takes place at baptism, the repentant sinner is transformed from a state of sin to the state of grace. Peter mentioned this transformation from sin to grace when he exhorted people to "be baptized every one of you in the name of Jesus Christ for the forgiveness of your sins; and you shall receive the gift of the Holy Spirit" (Acts 2:38).
The context of Jesus statements in John 3 makes it clear that he was referring to water baptism. Shortly before Jesus teaches Nicodemus about the necessity and regenerating effect of baptism, he himself was baptized by John the Baptist, and the circumstances are striking: Jesus goes down into the water, and as he is baptized, the heavens open, the Holy Spirit descends upon him in the form of a dove, and the voice of God the Father speaks from heaven, saying, "This is my beloved Son" (cf. Matt. 3:1317; Mark 1:911; Luke 3:2122; John 1:3034). This scene gives us a graphic depiction of what happens at baptism: We are baptized with water, symbolizing our dying with Christ (Rom. 6:3) and our rising with Christ to the newness of life (Rom. 6:45); we receive the gift of sanctifying grace and the indwelling of the Holy Spirit (1 Cor. 12:13; Gal. 3:27); and we are adopted as Gods sons (Rom. 8:1517)."
http://www.catholic.com/library/Are_Catholics_Born_Again.asp
Jesus' statement is reinforced with these verses from Acts: