Theory:

     He went on to narrate how he sometimes saw ghosts at night. “I am not easily frightened by these things, sir. I am a brave fellow. But one horrible ghost of a woman which appears off and on at midnight during the full moon... It is an ugly creature with matted hair and a shrivelled face, like a skeleton holding a foetus in its arms.”

     Mahendra shivered at the description and interrupted rather sharply, “You are crazy, Iswaran. There are no such things as ghosts or spirits. It is all a figment of your imagination. Get your digestive system examined — and maybe your head as well. You are talking nonsense.
Explanation:
 
Iswaran continued his story. He stated that sometimes he saw ghosts at night, but he wasn't scared of them because he was a brave man. On the other hand, during the full-moon nights, he often saw a horrible ghost. It was an ugly female ghost with rough and unkempt hair and bony, wrinkled face. The ghost looked like a skeleton holding an unborn baby in its hands.
 
ghost-5676447_1920.jpg
Iswaran saw a female ghost

After hearing the frightful description, Mahendra became nervous, and he started to interrupt Iswaran from talking about the ghost. Mahendra was angry, and he scolded him and said that Iswaran had gone mad. Mahendra contradicted by telling that the creatures, like ghosts or spirits, did not exist in this world. He added that it was all about Iswaran’s imagination. Mahendra thought that it was all because of reading horror books. Mahendra asked, "Iswaran to get himself checked up with a doctor". He used the statement figuratively to suggest that Iswaran has gone mad as he was talking about ghosts in the middle of the night. In addition, Mahendra also asked him to test his digestive system. The reason behind the statement to get his digestive system examined was because people tend to lose sleep if there was some problem with digestion. So, that would lead people to imagine things that are not real.
 
Meanings of the difficult words:
 
S.No
Words
Meanings
1
FrightenMake someone afraid or anxious
2
Horrible Very unpleasant
3
Ugly Unpleasant or repulsive, especially in appearance
4
Shrivelled Wrinkled and shrunken, especially as a result of loss of moisture or old age
5
Skeleton The frame of bones supporting a human or animal body
6
Foetus An unborn child
7
ImaginationThe ability of forming new ideas, images or concepts of external objects not present to the senses
8
NonsenseSpoken or written words that have no meaning or make no sense
Reference:
National Council of Educational Research and Training (2006). Moments. Iswaran the Storyteller– R.K. Laxman (pp. 12-18). Published at the Publication Division by the Secretary, National Council of Educational Research and Training, Sri Aurobindo Marg, New Delhi.