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If you want to use a variable in password filed of your data server then thats fine. But you need to make sure that the variable must be the 1st step of your package which contains the value (password). ( I know this is not a recommended way but any one can exploit the flexibility available in ODI as per the requirement )
Now if you want to use an encoded password thats not going to work here. You have to use one algorithm that will convert the encoded password to the actual password in the beginning of your package and then you can pass to the variable which will be used in the data server.