The narrator wonders what reason Claggart could have had for being down on the innocent Billy Budd. The narrator admits it would be easy to invent some incident involving the two before Billy joined the ship, in order to improve the story, but there was no such incident. Claggart seemed to spontaneously dislike Billy.
The narrator again highlights his ability to fabricate aspects of the story, but insists that he is relating a truthful tale. But if it would be easy to invent something here, wouldn't it also be easy to lie elsewhere in the story? Yet, at the same time, the narrator is making the points that there are feelings between people that develop that defy all explanation.
In attempting to explain Claggart's dislike of Billy, the narrator notes that life at sea necessarily puts very different personalities in close contact: at sea, one has to deal with all sorts of people in the confined space of the ship. But even this does not explain Claggart's malicious nature. The narrator digresses about how difficult it is to know one's inner nature. He suggests that Claggart suffered from some "natural depravity" but does not explain more.
Claggart's inner motivations and character are fundamentally a mystery. However, the narrator still sees his actions as arising from his innate nature, from a natural depravity that the narrator does not identify further.
The narrator tells the reader that Claggart exemplifies the most dangerous kind of madman: he is not always mad and so can blend into normal society most of the time. The narrator again concludes that Claggart had some innate evil, a "natural depravity."
Despite his evil character, Claggart has a deceptively normal appearance and behavior. It is this lack of correspondence between appearance and inner character that makes him dangerous. This idea also complicates the narrator's sense of the importance of one's external looks. It might be more accurate to say that you can trust external appearance, except when you can't. It's interesting to speculate whether Melville, the author, does not actually agree with his narrator's focus on physical appearance as proving inner nature.