As per Rajiv Malhotra, Max Muller played double game. Although he tentatively proposed some (strange) theories, Rajiv Malhotra says later scholars used his speculations and solidified concept of Arya and Dravida and destroyed dynamic nature of Varna Dharma. His interpretations can be considered as distortions which were later used by other scholars.
Rajiv Malhotra says the following in Chapter 5 of Breaking India book:
Max Müller's interpretation of Vedic literature in terms of a clash
between two racial groups, led him to search for physical features in
the Vedas that would identify the groups physically. And so, Müller
tentatively interpreted nose-length as one such differentiating
Sir Herbert Hope Risley (1851–1911) was a powerful colonial
bureaucrat at the Royal Anthropological Institute, and developed the
Nasal Index based on Max Müller's speculation. This Nasal Index, much
like Phrenology, became a tool of Race Science in an effort to
classify the traits of Indian communities. During the four decades of
his stay in India, Risley made an extensive study of Indian
communities, based on the Nasal Index. His goal was to separate the
Aryan communities from the non-Aryan communities.
classification and massive documentation of Indian jatis froze the
dynamic quality and mobility found in the jati system within the varna
matrix. Various colonially inspired studies transformed jatis into
racial categories rather than identities based on occupation. The
Nasal Index not only separated the jatis into Aryan and non-Aryan, it
also classified those considered non-Aryan as distinct from mainstream
Hindu society. Risley compared the black plantation-workers in America
with the so-called non-Aryan communities in India. This foreshadows
the Afro-Dalit-Dravidian projects of today, which are essentially the
expansion of Risley's project of ethnic fragmentation of India.
Rajiva Malhotra says Rigveda 5.29.10 was used to classify Indians tentatively as Aryans and Non-Aryans.
Max Müller's interpretation of the Rig Veda claimed that only the
first three varnas are Aryan, while the fourth, shudra, is not Aryan.
However, he explicitly admitted that there was no evidence of physical
differences between Aryans and non-Aryans in Sanskrit texts. He made
only one incidental reference to physical differences – that noses
were described differently for different tribes in the Rig Veda. He
based this notion on a single Sanskrit word, anasa (Rig Veda:
V.29.10), that was used infrequently. Müller himself drew no important
conclusions from this casual observation. But his prejudice was passed
on through others who were more eager to do the dirty work openly. One
of the common threads throughout the West's study of India has been
the manner in which subsequent scholars pick and choose from someone
else's work, often out of context, and with their own arbitrary
assignment of priorities. This is what happened between Max Müller's
writing and its manipulative use by Risley years later.
Rajiv Malhotra also says Max Muller publicly criticized such theories but privately encouraged such interpretations.
The younger Risley was greatly influenced by the senior and legendary
figure of Max Müller. The development of racist theories between these
two men was an important step in shaping the future identities of
people across India. Publicly, Müller was cautious and wanted to
protect his image, so he criticized the use of linguistics for racial
profiling. But indirectly and privately, he encouraged it in various
ways. For instance, Müller gave the following input in a private
letter to Risley, prior to Risley's census of 1901:
It may be that in time the classification of skulls, hair, eyes, and skin may be brought into harmony with the classification of language.
We may even go so far as to admit, as a postulate, that the two must
have run parallel, at least in the beginning of all things.
In the same letter, he encouraged Risley by saying that students of
ethnology have regarded 'the skull, as the shell of the brain' to be
an indicator of 'the spiritual essence' of the person. In other words,
Max Müller spoke from both sides of his mouth when it came to racial implications of cultural and linguistic factors. This ambiguity was
often deliberately nuanced in codified terms, which enabled more
blatantly racist men like Risley to proceed further.