I am using the DB2PreProcessor on OS-390 z/OS.
The very simple program shown below fails:

#include <sqlca.h>
EXEC SQL INCLUDE SQLCA;
int main(int argc, char *argv[]) {

EXEC SQL BEGIN DECLARE SECTION ;
char st[80];
EXEC SQL END DECLARE SECTION ;

EXEC SQL PREPARE s1 FROM :st ;
}

The error that it gives is:
DSNH080I E DSNHSM3D LINE 9 COL 28 STRING VARIABLE "st" IS NOT "VARCHAR" TYPE

Does anyone know what is going on?

Is it that you have defined st as CHAR, the error message is requesting it be VARCHAR

No, I tried that. The pre-compiler does not recognize VARCHAR as a data type.

I would suggest you precompile and compile a sample program(Which comes with the DB2 product) and use the sample compile JCL. I think something is wrong with your compile options.